By Priyank Srivastava
I admit it, I was wrong.
Had you asked me in the month of January 2015 where the oil price the following year (second quarter of 2016) would be, I was somewhat confident that it would be more than $75 a barrel. If you see the history of oil prices, you will realise that it is cyclic in nature. However, looking into the current state, I believe that cheap oil is here to stay, perhaps even for years to come.
Crude oil markets are a function of innumerable variables — demand-supply economics, geopolitics, technology, geology, speculation and, to no surprise, it comes with its unique characteristic ambiguity. But today, speculation and geopolitics have become the two most probable culprits behind any price spike, overshadowing the basic demand-supply issue. More than 50% of the oil price movements are purely speculative. There are many issues going on – Saudi and Iraq is pumping more oil to defend market share, the Iran sanctions relief, the US shale industry crisis, the slowdown in China, etc. Even if you do get your oil-price predictions right, you never know when a warlike situation in Iraq or Syria may appear or a probable massive discovery rolls the ball in the opposite direction.
Though analysts and industry experts always come up with a number, they can’t rely on it. According to the Saudi oil minister1, triple digit oil prices may be a thing of the past, whereas the OPEC Secretary-General2 sees a real probability of oil prices reaching up to $200 a barrel in the future.
The Impact of Shale Oil
Over the last decade, the use of horizontal drilling and hydraulic fracturing technology accelerated and became widely available. With crude prices averaging from $80 to $130, it was highly rewarding to drill more. During this period, capital was almost unlimited for energy companies, and the number of oil rigs operating in the U.S. surged from 300 to more than 1,500. But the surge in production brought the inevitable overreach which, eventually, made the prices decline.
Sources: EIA and Baker Hughes
Production is likely to stabilize near current levels for a few quarters, but a significant drop-off in production is unlikely. The figure may continue to slowly edge higher in coming years. This is despite the large drop in the oil rig count. Several factors are likely to push production forward in the intermediate term. Firstly, drilling efficiency has continued to improve. Secondly, every well is different, which means a drop in its numbers doesn’t create a one-for-one production reduction. High-production wells will continue to be drilled, and account for the majority of actual production. Marginal opportunities will be cancelled, and would have a limited impact on production. Finally, a 25-40% cost decline from the peak indicates a rebound for drilling rigs after a period of current level stabilization.
Prices ranging from $60-$80 are likely to create the balance. At this range, many energy sources will be uneconomical, though opportunities will keep emerging. The lower prices will create more self-control in the industry while continuing to boost technical advances.
The Geopolitics of Oil
Over the last four decades, OPEC has been the single swing producer of crude oil. Specifically, Saudi Arabia has the ability to ramp up production and export quickly. This has allowed them to control the oil market. In the last five years, the biggest change that has happened is the creation of an oligopoly in the oil market due to the rise of the U.S. Oil production in the US has increased by more than 4 million barrels per day, which is almost double the level of production in 2009.
An Iran-US nuclear deal could bring a flood of oil. Iran could set free an estimated 30 million to 40 million barrels of oil it now stores on super tankers off the coast3. Oil prices would immediately reflect the above sudden supply. Moreover, Iran holds the world’s fourth-largest proved crude oil reserves, an estimated 157.8 billion barrels of oil – 9.3% of the entire world’s oil reserves4. Iran is eager to quickly ramp up its oil production after the sanction relief to support its ailing economy. It is expected to add 1 million barrels per day in a month or so after the sanctions are lifted. This will further put a downward pressure on the oil prices.
The oil giants are saying that the future outlook is not a positive one. US supermajors such as Chevron, ConocoPhillips, and ExxonMobil signalled that the future looks blurry at this moment and that we might see low oil prices for years to come and suggested that oil supermajors will have to get used to lower prices.
What the future holds?
With the US oil rig decline, oil production levels are finally set to show a declining trend. OPEC concentrated on pushing the US shale drillers out of the game. But the US shale industry has proved more robust than anticipated. Advancements in technology are leading to reduced costs. It is the speed of shale oil production and the capital environment that will determine the prices of crude oil.
Over the next two to three years, it is expected that the prices would settle in the range of $60–$80. But companies that had business models floating on $100 oil will sink first, and the industry will progress and strengthen during this next chapter of the energy revolution.
Priyank Srivastava works as a Senior Analyst specializing in oil & gas for MarketsandMarkets, a full-service market research and consulting firm. He has written reports on strategic issues impacting the oil & gas industry, and has authored a number of articles in oil & gas magazines and journals.