While
hard commodities are going through very tough times, crude oil has grabbed most
of the headlines, and no wonder: its derivative, gasoline, is an essential product
that billions of human beings consume every day. Oil is also associated with the most volatile
areas of the world which are making the headlines of newspapers and TV evening
news.
What is striking is how linear and steady the rise in global demand has been over the last 20 years. Yes, the Great Recession of 2008-2009 cut demand by some 3 million bpd, but that drop was erased in less than 2 years.
After peaking at 9 million bpd in 1986, US production steadily decreased to 5 million bpd in 2008. However, thanks to the development of shale extraction, it skyrocketed to 9.6 mm bpd in June 2015 before falling to 9.2 mm bpd by year end. From the end of 2011 to the middle of 2015, shale oil production grew at an astounding annual rate of about 1 million bpd!
Crude
prices have fallen from over $100 per barrel in the summer of 2014 to under $30
today. Some experts foresee $20 and even
$10 before any rebound takes place. Are
they right? A better question is whether
such collapse is cyclical or secular. Crude
oil is a global commodity, largely driven by supply and demand.
Two
charts are most instructive in this regard.
The first one shows the quarterly global demand for oil from 1Q 1996 to
3Q 2015:
Source: Bloomberg.
What is striking is how linear and steady the rise in global demand has been over the last 20 years. Yes, the Great Recession of 2008-2009 cut demand by some 3 million bpd, but that drop was erased in less than 2 years.
Despite
a short but a massive global recession, global demand for oil has grown fairly consistently
at a rate of 1.5% p.a. The supposed
crumbling of the Chinese economy is not apparent over the 2010-2015 period; indeed,
Chinese demand for gasoline grew by 12% in 2015 over 2014[1]. It is also interesting to note that the
demand for oil kept rising steadily from 2002 to 2007 and from 2009 to 3Q 2014 despite
prices soaring from $19 to $91 and from $36 to $94 respectively.
Put
it another way, global demand for oil is fairly price inelastic over the medium
and long-term; despite claims that fossil fuels are on their way out, there is
little evidence that demand is falling, and I doubt that this will happen for
the next few decades.
The
second chart shows US oil production over the 1983-2015 period. It does much to explain why prices have
suddenly dropped. Or why OPEC, and Saudi Arabia in particular, have
decided to no longer play the role of market moderator.
Source: Bloomberg.
After peaking at 9 million bpd in 1986, US production steadily decreased to 5 million bpd in 2008. However, thanks to the development of shale extraction, it skyrocketed to 9.6 mm bpd in June 2015 before falling to 9.2 mm bpd by year end. From the end of 2011 to the middle of 2015, shale oil production grew at an astounding annual rate of about 1 million bpd!
With
oil at $100 shale was a terrific business.
At $40, it is a losing proposition for most. Already, US shale production has dropped by
400,000 bpd since June of 2015.
Estimates of another 600,000 bpd cut this year are reasonable, for a
cumulative 1 million bpd.
When
might global oil markets get back into balance and prices rise to a range of
$50-$70 which would permit the commercial exploitation of most sources of crude
except for the more expensive shale and oil sands?
If
we assume that the sudden oversupply of shale oil caused the current imbalance,
then the secular annual increase in global demand of 1.5% (or about 1.4 mm bpd
today) should take 3 years to close the gap, everything else being equal[2]. This would get us to the end of 2018.
But
it is unreasonable to assume no extraneous factors, especially in today’s world.
First,
as we indicated earlier, US shale production is likely to fall further,
probably by another 600,000 bpd this year.
This decrease will probably be compensated in large part by increased
Iranian exports of 300,000 to 500,000 bpd.
Towards
the end of projection period, drastic cuts of close to 40% in investments made
so far by the oil industry are bound to result in flat, not rising,
production. Among the world leaders,
Petrobras for one has already massively scaled back its growth and may be
forced to do more.
Geopolitical
factors may cause more significant swings in global supply: Venezuela is
teetering on the edge of economic chaos; Libya is in even worse shape. The
second largest OPEC producer with 4.4 mm bpd, Iraq is in a state of war with IS. And then there is the rising tension between
Iran and Saudi Arabia where the principal actors don’t want a war but do want
to test each other. Russia is strapped financially and barred from access to the best of western petroleum technology.
Between cuts in US shale, increases in Iranian exports and difficulties faced by OPEC and non-OPEC producers, it is not unreasonable to envisage a net reduction in global supply of 800,000 bpd to 1 mm bpd over the next three years.
Between cuts in US shale, increases in Iranian exports and difficulties faced by OPEC and non-OPEC producers, it is not unreasonable to envisage a net reduction in global supply of 800,000 bpd to 1 mm bpd over the next three years.
Finally,
there is the reality that at least 5 mm bpd of new production must be ramped up
every year to make up for natural field depletion. That costs money. A lot of money.
I
don’t know what the oil prices will be this year or the next. However, I think that, barring major geopolitical accidents or a recession, the global oil market should get back close to equilibrium by early 2018 through a combination of lower production and higher demand. Financial markets should anticipate that by six months or so.
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