The Other Side of the “Oil Glut”
The pundits continue to hawk the same reasons for the fall in oil prices.
These are always “spearheaded” by comments about surging global supply led by the onslaught of unconventional (tight and shale) oil production in the U.S.
Invariably, what’s missed by these “TV sages” are the pricing dynamics kicking in that virtually guarantee an increase in oil prices as we move into 2015.
They’re based on the actual condition of the oil market, not some knee-jerk emotional commentary delivered by the talking heads on TV (some of whom are actually short the market).
The good news is more of the guys who really understand what’s going on have begun to mirror what I have been saying for some time – including some well-known economists.
One of them is Steve Kopits, the high-profile managing director of Princeton Energy Advisors, who recently came out with a particularly bullish projection…
According to Kopits, “In permitting low oil prices, the Saudis seek to bring the market back into equilibrium. At present, our calculation of break-even system-wide is in the $85-$100 a barrel range on a Brent basis.”
But Kopits isn’t the only one who’s optimistic about oil. The legendary Mark Mobius, the emerging market guru, chimed in this week that he expects Brent to rebound to $90.
Oil Prices: A Significant Squeeze Ahead
This move higher in oil prices won’t happen overnight. Instead, it will happen gradually.
Absent any move by OPEC to cut production – an unlikely short-term prospect given the current Saudi position – it will be driven by traditional supply and demand factors. In fact, the current low price environment is actually setting the scene for a major uplift in prices.
A read earlier this week by Dan Steffens is illuminating on this point.
Dan Steffens is one of the best (and most readable) analysts you can find. He and I have had a like mind for some time on what the real impact is going to be from the current “oil glut.”
According to Dan, the current low crude oil price could be overkill and result in the next “Energy Crisis” by early 2016.
As Dan notes:
“The upstream U.S. oil companies we follow closely are all announcing 20% to 50% cuts in capital spending for 2015. We will start seeing the impact on supply at the same time the annual increase in demand kicks in. Our model portfolio companies are all expected to report year-over-year increases in production, but at a much slower pace than the last few years.”
“A study released by Credit Suisse two weeks ago shows that U.S. independents expect capital-expenditure (Capex) cuts of one-third against production gains of 10 per cent next year. This would imply production growth of 600,000 bpd of shale liquids, and perhaps another 200,000 bpd from Gulf of Mexico deepwater projects. At the same time, U.S. conventional onshore production continues to fall. I have seen estimates of 500,000 to 700,000 bpd declines within twelve months. If these forecasts are accurate, U.S. oil production growth would be barely positive next year and headed for a material downturn in 2016.”
“North American unconventionals (oil sands, shale and other tight formations) have been almost all of net global supply growth since 2005. If unconventional growth grinds to zero and conventional growth is falling outright, the supply side heading into 2016 looks highly compromised. At today’s oil price, only the “Sweet Spots” in the North American Shale Plays and the Canadian Oil Sands generate decent financial returns to justify the massive capital requirements needed to continue development. Global deepwater exploration is rapidly coming to a halt.”
“Were demand growth muted, this might not matter. Demand for liquid fuels goes up year-after-year. It even increased in 2008 during the “Great Recession” and ramped up sharply during 2009 and 2010 despite a sluggish global economy. Low fuel prices are increasing demand today and my guess is that, with U.S. GDP growth now forecast at 5% in 2015, we could see demand for fuels increase by close to 1.5 million barrels per day this year. The current IEA forecast is for oil demand to increase by 900,000 bpd in 2015.”
And here’s the kicker…
“Low fuel prices are increasing in demand today and with U.S. Gross Domestic Product (GDP) likely to come in higher (about 5% is the current consensus) in 2015, demand would increase by almost 1.5 million bpd this year. The current International Energy agency (IEA) forecast is for oil demand to increase by 900,000 bpd in 2015.”
As a result, more analysts are beginning to conclude that the oil markets will be heading into a significant squeeze.
The Coming “Oil Shock”
Dan and others also put emphasis on the real supply side quandary.
The last extended period of low oil prices was from 1985 to 1990. In 1985, when oil prices collapsed in a similar fashion to what is occurring today, the world had 13 million bpd of spare capacity, with 7 million of that in Saudi Arabia. OPEC was well-positioned to comfortably meet any increase in demand.
Today, just about all of the world’s discretionary spare capacity resides in Saudi Arabia and amounts to no more than 2 million bpd. Oil expert Lou Powers says that Saudi Arabia will have difficulty maintaining production at over 10 million bpd for an extended period. If we do swing to a supply shortage, the Saudis may find themselves needing to open all production for a prolonged period of time. Lou says at that point the world will be headed right back into an oil shock and we will see much higher oil prices than $100 per barrel.
Recall that only North America and deep water projects are the only places with meaningful production upside. If crude oil prices remain below $60 a barrel for any length of time it could prove catastrophic to non-OPEC supply. At some point, OPEC action may become necessary.
But some are pointing elsewhere. Steve Kopits says that the cut may not initially come from either Saudi Arabia or OPEC. “OPEC could cut production to prop up prices and increase revenues,” Steve says. “But for now, a better strategy for Saudi Arabia would be to hang back, deflect criticism, and let events play out. If the Russians are thinking clearly, Moscow will cut first.”
As a result, I have started to set up my Energy Advantage and Energy Inner Circle subscribers for the moves I’ll be introducing shortly.
Because there is one truism in all of this…
Before the spike in crude oil prices occurs, a range of highly profitable energy sector prospects will fall into our laps.
Seriously oversold markets have a way of doing that.