If you were to read all the articles on the oil price over July and August, the authors would have us believe that we're destined for below US$60 per barrel of oil until 2020 and we'll never see prices over US$100 again. Let's take a quick look at how we got to sub US$50 per barrel in the first place.
US Shale Oil Boom...
Looking solely at US Shale Oil production since 2007, it is no wonder that OPEC was caught off-guard by the pace of Shale Oil production growth. Production grew from just over a million barrels per day in 2007 to around 5.5 mmbbls/day at its peak earlier in April this year.
The Perfect US Strategy...
Talking with one high-level oil executive in September last year, we discussed the steady descent of the oil price from the US$100-plus mark. We came to the conclusion that oil was headed towards US$40-level. Why? Well not only was it a story about the shale oil boom in the US, but also Vladimir Putin.
In the spring of 2014, the US and Europe had become increasingly concerned with Putin's seeming desire to reclaim former soviet states. Although perhaps on the extreme side, Putin was compared to Hitler and unless the West took steps to mitigate his ambitions the situation could very well escalate further into a very real threat to the rest of Europe.
By August of 2014, the US Administration had succeeded in closing all credit lines from international banks to Russia. No mean feat (Quite an undertaking in itself).
With those deals secure, the oil price marched steadily south due to rising production from the shale oil boom in the US. When it came to the crunch decision by OPEC in November, the market thought OPEC would cut production to bolster prices. They were wrong. I happened to be in Vienna that day. I posted on Oilpro, in response to a question asked by Farizah Asker, that they would not cut production under the heavy influence of Saudi Arabia, in between sips of my latte at Starbucks, just at the end of the street from OPEC's HQ.
Subsequently some commentators suggested, Saudi Arabia, at the behest of the US Administration, would likely increase production further, sending the price spiralling downwards. From a US geopolitical and economic strategy point of view this would be a stroke of genius. This sole decision by OPEC would not only drop prices, hurting the US's "enemies", it would boost the world-wide economy, particularly the Eurozone which was floundering. More importantly, it would put the US economy on a solid-footing going into the election year of 2016. Those who depended heavily on a high oil price, without sufficient monetary reserves to maintain their domestic spending, would hurt the most; chiefly Russia.
We witnessed the fall-out of lower oil prices towards the end of 2014. With no access to international credit-lines and the oil price plummeting, the Russian central bank had to raise interest rates to 17% in December - an emergency move to stem the slide of the Rouble against the dollar. Inflation is currently around 11% and recent Q2 GDP data reported the economy had shrank by 4.6%!
US Shale And Non-OPEC Supply To Decline...
Shale production decline is a reality. Overall decline rates in the Bakken Shale are around 50%, Eagleford Shale 55% and the Permian is around 25% and the US rig-count has now fallen by over a half. So why have we not witnessed anything yet?
Well the answer to that is a mixed and somewhat cloudy one. Delays in completing some wells are clouding the decline picture as are delays in actual hard production data. The answer to the delays in both cases is around 4 months. We have to wait around 4 months to get the actual data for what is happening now, and quite often wells are not completed until some 4 months after they have been spudded.
Some have asked why oil companies in the US have not colluded to shut-in production and wait for higher prices. The simple answer, many smaller oil companies must continue producing to keep paying-off the loans that financed the well in the first place. A fact that the banks and bond-holders that have financed some of the more risky ventures are about to find out to their cost.
But these delays that appear to be clouding the picture right now are only delaying the inevitable. Decline is happening and the market will be some four months behind the fact. We have already witnessed what happened in early 2009 when the oil price hit the low $30s (In real-terms the same as the recent lows of last week). In just two financial quarters, World oil supply dropped over 2 mmbbls/day with Saudi Arabia accounting for around 1 mmbbls/day - and this being a scenario before the more significant production supply levels we have from US Shale oil in the present.
Estimates of US Oil production declines of over 500,000 bbl/day by the end of Q4 this year have been touted. Factor in declines from the rest of non-OPEC supply and the current over-supply situation will not last long.
Iranian Crude Supply Fears Are Misdirected...
Despite the worries of extra supply coming back onto the table from Iran, perhaps as early as November, the expectations are perhaps a little exaggerated. Indeed Iran may have millions of barrels in storage ready to supply the market. However, as for immediate production abilities, that will take a little longer. Any production that Iran has shut-in over a long-period of time will take perhaps as much as 18 months to get back to full-swing. Beyond this, it is unlikely Iran will be able to increase its oil production much higher than 3.5 mmbbls/day without the aid of Western technology and know-how. Iran has been promising to boost production to over 5 mmbbls/day since 2005, but had difficulty in maintaining steady production even back then, never-mind increasing it.
However, it can be achieved with substantial international investment and the willingness of IOCs to get involved, but only if fiscal-terms are attractive. IOCs in the recent past have had their fingers-burned with the unfavourable and unpopular buy-back contracts. Project delays and CAPEX over-runs, often due to the necessity of having to use local Iranian companies, would have certainly left a bitter taste to those parties involved. Iran therefore must have a thorough re-think of its fiscal-terms if it is to attract the foreign investment in its petroleum industry that it so badly needs to benefit the people and its economy.
Worldwide Demand Trend Upwards...
Oil demand has resurged anew with the oil price currently below $50/bbl for both WTI and Brent. The IEA has had to revise its demand figures upwards again for this year and next with its forecast of 1.6 mmbbls/day growth this year. In fact, the underlying rate of demand growth is at just over 1.4 mmbbls/day year on year.
Back in 2003, estimates were made that if world growth proceeded at just 2% per year, oil demand would exceed 100 mmbbls/day before 2020. In order to achieve this, a much higher oil-price-scenario would be required, much higher than the historic US$20 per barrel price, in real-terms, to subdue demand. Otherwise, demand would spiral upwards above 120 mmbbls/day by 2020.
More recently, evidence of what exactly the low-oil-price-scenario has done for the world economy can be seen in the latest GDP releases. US GDP was reported at 3.7% last week, much higher than analysts were expecting. World GDP is likely to be above 3% this year and is forecast above 3% next year and into 2018, according to the World Bank group.
Oil Price Must Go Up...
This paints an interesting scenario. With major development expenditures in the order of over US$300 billion having been delayed or shelved for the time-being, world production declining and demand-growth accelerating, OPEC's buffer for spare capacity will disappear. Saudi Arabia alone is estimated to be eating into its substantial monetary reserves at the rate of well in excess of US$100 billion per year at prices below US$50/bbl. Taking into account that around 25% of the work-force has been cut by many O&G companies and service companies and the back-drop for an oil-price spike has already been painted. The world will not only need Iranian oil, but also the extra barrels from war-torn countries in the Middle East, just to play catch-up.
As the commodities expert, Jim Rogers said last week, "The cure for low prices is low prices." The decline in supply and the rise in demand is happening right now. It's not a matter of if the oil price will head back upwards, but when?