1
Will Oil Prices Settle?
WhoWhere
3D Prints
What in 2033?
INTRODUCTION
Oil is the world’s largest internationally traded good – in both volume and value. Rapid price hikes typically trigger
global recessions, but rapidly falling prices can do much the same through deflationary pressures and debt failures.
Fear, uncertainty and doubt in this market affect other markets as well. Over the last three months, the OPEC Reference
Basket (ORB) price has dropped by half, declining from a June 2014 peak of US$107.00 to $45.69 per barrel on January
26, 2015. At this price point, nine of OPEC’s 12 members are suffering budget revenue shortfalls, and yet no action was
taken at a recent OPEC meeting to curtail production. Instead, the rapid price cuts were essentially endorsed by Saudi
Arabia, the leader of the oil cartel, whose members are focused on market share amidst North America’s oil production
boom and weaker global demand for oil as China, the EU and other economies slow down.
In January, 2015 Wikistrat ran a two-week simulation entitled “Where will Oil Prices Settle?”, aiming to identify the key
variables and actors at work in the movement of oil prices across global markets. This simulation had two phases, and
was performed using a qualitative approach to market analysis. In the first phase, analysts explored the key geopolitical
variables that shape oil prices. In the second phase, they analyzed how those factors would impact OPEC and other oil
producers, as well as non-OPEC oil producing countries like the United States (U.S.), Russia and others.
ABOUT US
Wikistrat is the world’s first crowdsourced consultancy. It leverages a global network of subject-matter experts
via a patent-pending “Collaborative Competition” methodology to provide a variety of analytic services. Scenario
generation, policy planning, risk assessment and red-teaming exercises are conducted by Wikistrat on a realtime, interactive online platform.
2
RAPID REBOUND
The simulation analysis saw little prospect for a rapid rebound of oil prices to $80 a barrel over the next year.
Part of this was due to perceptions that while the oil market was oversupplied, the market fundamentals of supply and
demand per se were not the only factors sending prices down. These other factors include:
•
•
•
Geopolitical rivalry between Saudi Arabia and Iran is driving oil prices down. Saudi Arabia fears the recent
U.S. nuclear deal with Iran, which it sees as posing an existential threat to them and to other Middle Eastern
states. Driving down oil prices is seen as Saudi Arabia’s best weapon to deprive Iran of the resources to continue
sponsoring the nuclear program and to sponsor proxies that create problems across the Middle East.
Saudi pique at Russia and Syria, which are seen as enabling Iran to project its hegemonic influence across
the region, as well as the longstanding antipathy between the Saudis and Syria’s Bashar Al-Assad. Iran has been
ruthlessly effective at spreading its influence across the Middle East, and its rivals fear that will get worse if Iran
gets the bomb or gets a deal with the West that does not stop its nuclear program. The Syrian civil war is costing
Iran dearly to try to save Al-Assad, so driving oil prices down amplifies the pain of that cost on Iran on top of
Western sanctions.
The Supply Growth of the U.S. Shale Revolution. The market perceives the U.S. shale revolution as an unqualified
success, bringing substantially more oil and natural gas to world markets and reducing the U.S. demand for oil
imports. Saudi Arabia in particular is worried that the U.S.’s success with hydraulic fracturing and horizontal
drilling with spread around the world, increasing domestic oil supplies in many markets – especially China – and
cutting into Middle East producers market shares.
Market fundamentals of supply and demand suggest that if supply is too high and prices too low, U.S. shale producers
will delay investments in new drilling and development until prices rebound. However, even as new projects are delayed,
oil production continues at completed wells. The practical effect is that the while the U.S. delays future drilling projects
as oil prices fall, its overall oil production in 2015 is still growing and produces more than it did in 2014. This is not
what OPEC wanted to see happen, and pressure is growing on Saudi Arabia to cut production even from OPEC members
heavily dependent upon oil revenue.
Lower prices do lead to a chill in international shale development as tough geology and lack of technology, expertise and
both pipeline and storage infrastructure make the overall cost of shale development higher than alternative conventional
resources.
The bad news for producers is that even the rapid rebound scenarios in the simulation saw oil prices at $60 per barrel
at the end of 2015, $66 at the end of 2016, and $69 at the end of 2017. In addition, even the scenario of forward advance
from ISIS in Iraq (and other supply disruptions) saw prices rebound only to $80 per barrel at the end of 2015 before
falling back in 2016 and 2017, since oil supply availability elsewhere was adequate to meet demand.
Price volatility remains likely, but when price spikes do occur they rapidly reverse themselves. The reasons for this are
curiously focused on market psychology more than market fundamentals, including:
•
•
Prices fail to rapidly rebound because while China’s demand for oil is down, it “buys low” to fill its strategic
petroleum reserve while oil is “on sale”. China buys up to one half of the daily excess in swing oil in the markets,
but anytime its purchases cause a price spike it backs off until they settle down again. Just as the Saudis seek to
hold production up to drive prices down and achieve their geopolitical objectives, China uses oil purchases at
‘fire sale’ prices to accelerate filling its strategic petroleum reserve. However, China monitors and meters those
purchases to keep prices soft for as long as possible.
Traders bet on contango. Traders, betting on contango market conditions where oil prices in the future are
higher than today, lease storage tankers to buy cheap oil today hoping to sell it for a profit tomorrow. The question
Commercial in Confidence
Copyright © 2015, Wikistrat Inc.
All Rights Reserved. Patent Pending.
3
•
•
is, when will tomorrow come? Most leases are at least one year and some are longer, which has the effect of
dampening oil prices since supply is greater than demand.
Producer costs are being squeeze. Producers have complained over the past several years about the rising
costs of new drilling projects as the U.S. shale revolution has grown substantially onshore in North America and
competition for rigs for deep water projects has driven up prices. As much as the super-major and major oil
producers want to grow their oil and gas reserves to enhance the value of their portfolio, they want projected
exploration & production (E&P) costs to go down even more. Low oil prices put pressure on oil field services
firms and other suppliers to cut their prices and better reflect the lower demand in new drilling and production,
thus squeezing the costs, improving productivity and re-ordering the priorities of new projects based upon
improved E&P economics. An intended consequence of lower oil prices has been to improve the productivity of
the oil and gas industry and reset pricing expectations for suppliers now forced to compete for the business.
National oil companies dependent upon oil revenue are in crisis. Lower oil prices are an equal opportunity
punishment for both OPEC members (such as Venezuela, which is heavily dependent upon current oil revenue)
and non-OPEC producers like Russia. In the past, cuts in OPEC production targets have meant that many OPEC
members agree to Saudi Arabia’s demands and then cheat on their own production to gain market share, leaving
the Saudis to do the heavy lifting of reducing their own production and market share to reach the overall target.
Holding at a production level punishes the cheaters with loss of oil revenue. Low prices prove a very effective
strategy for Saudi Arabia and the Gulf states to use against rivals like Iran, Russia, Syria, Shiite-controlled Iraq,
and Libya.
SLOW REBOUND
There were many more scenarios proposing a slow rebound in oil prices to $80 a barrel over the next three years. These
scenarios tended to identify actions that sweat the cost out of operating expenses and deferred new capital investment
to get the project economics back into alignment, given weaker demand and lower prices over the three-year horizon.
•
•
•
Drive out high cost producers. both from conventional and unconventional sources so oil market supply is
better balanced with world oil demand. Low oil prices have the effect of delaying expensive new projects as
slowing demand weakens the economics of expensive deep-water offshore projects. Perversely, existing high
cost producers like the Canadian oil sands keep producing from operating projects even as they slow down new
project development because many of their costs are fixed and their planned pay-back is much longer term. But
investment in maturing fields in the North Sea and elsewhere are delayed under these scenarios.
Low oil prices as economic stimulus. While low oil prices hurt producers they have powerful and positive
economic impacts on consumers, ranging from lower inflation concerns to lower gasoline prices, lifting spirits
as well as economic activity. Former Treasury Secretary Roger Altman recently stated that falling oil prices may
produce as much as $200 billion in economic stimulus to the U.S. economy in 2015. This is hardly bad news, and
similar positive impacts are felt in other oil consuming countries.
Enhanced oil recovery. Enhanced oil recovery (EOR) is an attractive disruptive technology for economically
extracting greater amounts of oil from a potential reservoir. EOR could become an important market balancing tool
in the future if it enables maturing fields to use new technology to restore declining production rates. Depending
on oil prices, EOR can compete with green field projects. Even at current low price levels, EOR costs at the Primary
and Secondary levels can be attractive in some cases. Tertiary recovery costs more and application varies greatly
to achieve near term profitability.
4
Crude oil produced from carbon dioxide injection in AEO2014, by case (2005-40)
million barrels per day
1.0
history
High oil price
projection
Low resource
Reference
High resource
0.8
0.6
Low oil price
0.4
0.2
0.0
2005
2010
2015
2020
2025
2030
2035
2040
Source: EIA
STABILIZATION
Where will prices settle? The scenarios in this simulation found stabilization of oil prices around $60 per barrel over the
three-year study period to be based upon how several key factors play out, including:
•
•
•
China rebalances its economy away from exports to a focus on sustainable domestic consumption. This
change is seem as taming the voracious appetite for commodities in the Chinese economy, as export revenue share
is replaced with services, property and other factors that make China a robust growing economy. It encourages
more internal development. Forecasts for such a Chinese soft landing are growing with IHS forecasting China’s
economy will slow from its frenetic pace of the last decade to 6.5 percent in 2015 and 6.8 percent in 2017.
Saudi attempt to derail the U.S. shale revolution fail. In the simulation, oil prices settle from $50 to $59 per
barrel over the three-year period, driven in part by continued growth in U.S. oil supply production. The U.S. shale
revolution and advances in fracking and horizontal drilling technology have certainly been game changers. The
world has plenty of oil today from production growth by non-OPEC countries around the world, as well as the
technology prowess of super-majors successful drilling in the deep water and ultra-deep water outside of the
Middle East. The U.S. continues to import oil for specialized purposes, but it also becomes a very competitive
global producer and exporter of crude oil, oil products and liquid natural gas.
OPEC loses market share. The practical effect of a rebalanced China and growing U.S. oil production is an erosion
of OPEC market share, and prices settling much lower than many producers want. Even at prices of $59 by 2017,
production growth continues in the U.S. to support faster economic growth there, and because of improved
productivity and lower break-even points as the fat is sweated out of the value chain. The Saudi decision to hold
oil production levels higher than required to clear demand is coming to be seen as a tipping point – not a display of
OPEC market power, but rather an admission of OPEC market weakness. OPEC wrongly expected that prolonged
low oil prices would drive unconventional onshore U.S. producers out of the market.
Commercial in Confidence
Copyright © 2015, Wikistrat Inc.
All Rights Reserved. Patent Pending.
5
SLOW SLIDE
Further slow decline in oil prices to $40 a barrel in the next three years can be driven by good as well as bad news in
global markets. This pathway in the simulation includes scenarios which find the following:
•
•
•
•
Factions in Libya’s civil war coming together in a new government. Libya has the largest oil reserves in Africa.
Before the Qaddafi regime fell, Libya was exporting 1.6 million barrels/day, mainly to Europe. During the civil war,
oil exports stood at about 700,000 barrels a day by the autumn of 2014, and renewed fighting cut this back to
only 350,000 barrels by year’s end 2014. This slow slide pathway assumes a scenario where the fighting ends and
Libyan production recovers to 1.3 million barrels per day, driving oil prices down to between $40-50 per barrel.
EOR technology using CO2 injections extends the life of mature fields, creating a race to the bottom as oil
prices fall but production levels keep growing. As producers fear a loss of market share due to field maturity and
more rapid decline rates onshore, they compensate by using EOR techniques to increase production volume,
trying to balance low prices and push competitors out of the market. However, this causes further oversupply in
the markets and softens prices.
U.S. oil & gas production is growing. Between 2011 and 2014 in the U.S. alone, oil production has increased from
7.8 ml. to 11.6 ml. barrels/day out of a world total of about 90 ml. The increase occurred almost entirely due to
increased production from shale (shale oil) obtained by adopting hydraulic fracturing and horizontal/directional
drilling (the latter also being used in conventional reservoirs). The U.S. are now closer to self-sufficiency and
evaluating the possibility of exporting oil to enjoy the greater prices there.
The International Energy Agency’s December oil market report observed a “sharp slowdown in Chinese
oil demand growth,” along with Europe and Japan as contributing to the weak outlook. It estimates total Chinese
demand growth of just 2.5 percent in 2014 and 2015, with gains in transport fuels and petrochemical feedstock
only slightly outweighing the weakening demand for gasoline, diesel and fuel oil.
RAPID SLIDE
The rapid slide pathway (less than $40 a barrel in the next year) is full of fear, uncertainty and doubt, and tended to
produce ugly outcomes as a result of the interplay of global events. One unintended consequence of low oil prices that
were raised during the simulation was that while it had a stimulating effect on consumer behavior, it did not increase
the demand for oil. This has profound long term implications for OPEC and other producing nations. As a result low oil
prices did as much harm as good, because they took so much economic activity out of the markets in such a short period
of time that the disruptions undermined confidence.
A second unintended consequence of low oil prices was the shattering of the myth that Saudi Arabia – with its
deep financial reserves – could outlast the North American shale producers to produce the desired supply
destruction. North American onshore producers responded to falling oil prices faster than expected by cutting capital
investment and delaying new projects. However, they kept completed wells producing, resulting in overall oil production
in North America continuing to grow longer than expected. There was a shake-out of weaker players in both the U.S. and
Canada, but those remaining were stronger and focused on improving productivity, and drove down break-even points
even lower.
A third lesson from this experience was that the Saudi policy of holding production levels up had the practical
effect of hitting OPEC members hard, undermining the cartel and producing as much collateral damage among
OPEC members as among non-OPEC, high-cost producers. Global oil prices settled down to nearly 50 percent lower
than their mid-2014 peak, which was hardly the outcome the Saudis has expected.
6
Other implications of the rapid slide scenario include:
•
•
•
Relative strength of the U.S. dollar drives down oil prices. Not only does growing U.S. oil supply affect oil
prices, but since oil is traded in U.S. dollars a stronger dollar compared to other currencies adversely affects the
market driving down oil prices in the conversion. A stronger U.S. dollar intensifies the impact of falling oil prices
and tends to cause other commodities – including food and metals – to fall. Commodities are thus down nearly
50 percent since mid-June 2014. Another factor that strengthens one currency over another – in this case the U.S.
dollar – is that economic growth in Europe and Asia is weak. The attendant low demand for many commodities,
especially oil, in those regions leaves markets with extra supply.
Commodity prices are falling not just for oil. The same thing that is happening in oil is also happening in other
commodities that, like oil, are priced in dollars. As the U.S. dollar strengthens, consumers and companies outside
the U.S. see their buying power shrink as their currencies weaken. Market volatility tends to create a market
psychology called “flight to safety”. As the U.S. economy shows signs of faster growth, the U.S. dollar strengthens
relative to other currencies. The U.S. Federal Reserve reported an improved economic outlook in its “beige book”
report, citing cheaper gasoline prices and stronger consumer spending. The Federal Reserve also said that it
expects 2015 U.S. economic growth to be up by 3.1 percent. According to the International Monetary Fund, the
Eurozone is predicted to expand by 1.3 percent and Japan by just 0.8 percent.
Perceived weakness in the Eurozone and especially weaker growth in China have a chilling effect on commodity
prices, and tend to add upward movement to the U.S. dollar. It is not all good news for the U.S., however, as a
stronger dollar makes U.S. exports more expensive.
Consumers are cheering at lower gasoline prices which act like stimulus. Falling oil prices are a doubleedged sword. While falling prices hurt oil companies and oil producing countries, they are a windfall to consumers
every time they fill up their gas tanks. The relative strength of the U.S. dollar is a material variable in determining
where oil prices settle. By some estimates, current low oil prices will provide the equivalent of a $200 billion tax
cut stimulus to U.S. consumers in 2015.
Commercial in Confidence
Copyright © 2015, Wikistrat Inc.
All Rights Reserved. Patent Pending.
7
KEY TAKEAWAYS
•
•
•
•
Oil markets today are in a continuing slow slide after a rapid slide fall from the June 2014 price highs to the
plunging impacts of OPEC November 27 meeting, holding production levels steady.
This slow slide is testing the bottom with prices in the mid to upper $50s per barrel. While events such as
worsening security concerns in the Middle East from ISIS and other terrorist groups can amplify the volatility, the
stimulating effect of low oil prices across the world economy suggests prices will settle around $60 per barrel.
Hopes that low oil prices would hurt North American domestic energy production and undermine the
advance of hydraulic fracturing appear unfounded. The tight oil producers have continued to improve drilling
productivity and efficiency, and low oil prices only incentivize them to do more to lower the break-even points.
The consequence is that the surviving onshore producers will likely end up stronger rather than weaker, as the
low oil price market environments weed out the weak in a ruthless Darwinian cycle. As prices rebound these
stronger players are then poised to ramp up production faster.
Low oil prices in a world economy that is seen as weaker today than it likely will be in the future sets up a
trading market behavior called contango. The result is that a growing share of current oil production is being
stored for future sale at higher prices. The rapidly increasing lease costs for floating oil storage tankers reveal that
contango behavior is hard at work – a further sign that oil prices may be settling.
8
ATTRIBUTIONS
[cover] This work, “cover”, is a derivative of refinery-pump-oil-pump-industry-514010,” by jp26jp, released into the Public Domain, “A UK Shell petrol station in
London in October 2007, listing the unleaded price as 98.9p a litre and the diesel price as 100.9p a litre. The picture was taken as the price of petrol in the UK began
to rise above £1 a litre (100p), and shortly after the price of unleaded also rose above £1 in this station,” by Billy Hicks, licensed under the GNU Free Documentation
License, “industry-industrial-plant-525119” by FraukeFeind, released into the Public Domain, and “Crude oil prices from 1861 to 2011 (1861-1944 WTI, 1945-1983
Arabian Light, 1984-2011 Brent) (yearly average in US dollars per barrel),” by Jashuah, licensed under the Creative Commons Attribution-Share Alike 3.0 Unported
license.“cover” is licensed under CC by Sheila Elizan.
Commercial in Confidence
Copyright © 2015, Wikistrat Inc.
All Rights Reserved. Patent Pending.