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"The Oil Crash: Why I Was Right"
Newsletter
October 21, 2014
Author: Leonardo Maugeri, Associate, Environment and Natural
Resources Program/Geopolitics of
Energy Project
Belfer Center Programs or Projects: The Geopolitics of Energy
Project
In my 2012 study Oil, the Next Revolution [1], I stressed
something that no one was seeing at that time(and much later as
well). As summed up by the opening sentence of the study:
Contrary to what most people believe, oil supply capacity is
growing worldwide at such an unprecedentedlevel that it might
outpace consumption. This could lead to a glut of overproduction
and a steep dip in oilprices. [2]
In the study, I summed up my forecast of the potential growth of
oil production capacity to 2020 in Fig.1,which is reported
below:
Fig. 1 World Oil Production Capacity to 2020
I also suggested that an oil price collapse could alter my
forecast, depending on the actual timing of sucha collapse: In this
framework, I considered 2015 as crucial for the oil market. This is
because:
Most of the projects I studied are still being developed, with
higher initial costs to adopt newtechnologies, build
infrastructure, and overcome the learning curve. The downturn or
collapse of the oilmarket would have a significant impact,
particularly if it occurred before 2015, when most of these
projects have yet to advance. However, the duration and effect
of such a collapse would probably be ofshort duration. [3]
Conversely:
if an oil price collapse were to occur after 2015, a prolonged
phase of overproduction could take place,because production
capacity would have already accumulated and production costs would
have decreasedas expected. This is what happened to shale gas
production in the United States between 2011 and 2012.In this case,
market recovery will depend critically on the strength of the world
economy as well asgeopolitical factors affecting the steady flow of
oil on the global market. [4]
I reiterated my views in a series of articles by observing that
the first crucial test for oil price resistancecould occur in the
second half of 2014, due to the continuous growth of production
capacity versus
sluggish demand, and in spite of geopolitical tensions affecting
the world. [5]
In 2012 I was alone in forecasting such a gloomy scenario (or
rosy, depending on the point of view) foroil, and my observations
based on a bottom-up analysis of world oilfields and oil
investments, not on
econometric models were regarded at best as controversial by the
vast majority of the analysts in thesector and by the oil industry
itself both envisioning very different outcomes. Until recently, on
the otherhand, all the major forecasting agencies and institutes
were anticipating bullish price and demandscenarios.
Still, my forecasts are punctually coming true, and the reality
is as it was clear.
After a cycle of strong investments in oil and gas exploration
and development started in 2003, since2010 an investment
super-cycle took shape: over a four years, national and
international oil companies
spent more than 2,500 billion dollars just in the upstream
hydrocarbons sector (oil and gas explorationand production).
That was an absolute historical record for the sector, even in
the presence of a specific inflationary
pressure which more than doubled upstream costs in the course of
a decade. Much of that investment hasproduced, or will produce,
results with a considerable time-lag, since in the oil industry it
takes years to
bring a given field to production.
The result is that new production capacity, or simple resilient
capacity from mature fields, is progressivelymade available just
while oil demand remains weak due to a still gloomy economic
outlook and will
continue to do so. Other factors contribute to worsen the
situation.
Thanks above all to the revolution in shale and tight oil fields
production, Unites States is currently
Oil Crash: Why I Was Right - Harvard - Belfer Center for
Science...
http://belfercenter.ksg.harvard.edu/publication/24653/oil_crash.html?b...
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producing over 4 million barrels per day (mbd) more with respect
to 2008, and is threatening Russias and
Saudi Arabias positions as world leading oil producers. It is
indispensable to clarify this point, due to theconfusion created by
official statistics and the media.
Saudi Arabia still holds the first place as far as oil
production capacity is concerned, at about 12.5 mbd.
However, to avoid flooding the world with oil, the Kingdom
maintains a spare capacity of about 3 mbd. Asa consequence, its
actual production is lower than Russias (10.6 mbd), and higher than
the United States(9 mbd as of October 2014). The US, however, is
producing over 1 mbd of biofuels included (togetherwith natural gas
liquids, or NGLs) in the oil production statistics provided by the
all major agencies.Adding these elements, and taking into account
the fact that the US is producing all it is capable of, in the
last few weeks America actually reached the top in the world
broadened oil production ranking at leastfor some days. But thats
not all.
US oil consumption is now 2 mbd lower with respect to its peak
(reached in 2007) partly as the result ofthe adoption of new laws
on energy efficiency and structural changes in consumer behavior.
Thecombined effect of a greater production and a lower consumption
is that US is currently importing over 5
mbd less than a few years back (and exporting a greater amount
of oil products), thereby endangeringthe interests of many large
and medium oil producers once big exporters and now compelled to
find newmarkets for their crude in a context of oversupply.
There are four main reasons which explain analysts inability to
understand what was (and is) going on:
Undervaluation of globalo i l p r o d u c t i o n c a p a c i t
y versus excessive focus on a c t u a l p r o d u c t i o n
which does not include voluntary or involuntarys p a r e c a p a
c i t y .
General tendency to viewd e c l i n e r a t e s of existing
oilfields simply as a function of time without
taking into account the effects of different
investment/technology cycles.
Constant, wrong view of both the a c t u a l c o s t s and the e
v o l u t io n o f p r o d u c t i v it y ofUS s h a l e a n d
t i g h t f i e l d s (this is true, however, also for shale
gas-fields).
Excessive reliance on f o r e c as t i n g t h e f u t u r e o n
t h e b a s i s o f m o d e l s that do not grasp the effects
of both specific investment cycles and advancement in knowledge
and technology.
Im working on a new short paper to address in more details these
four aspects. In any case, as Imentioned at the beginning, the
overall effect of the factors outlined is that global oil
production capacity
has been growing too rapidly and still does: It has already
exceeded 100 mbd (including biofuels andnatural gas liquids),
whereas demand is hovering around 92-93 mbd.
In the last weeks of September, actual oil production has
outpaced the 95 mbd mark, leading to
stockpiling (around 2 mbd) and leaving over 5 mbd of spare
capacity. Only Saudi Arabia maintains avoluntary spare capacity;
other countries do not supply all the oil they could due to
political instability
(Libya and Nigeria but also Iraq, Sudan and several others) or
international sanctions (Iran). If theircrude and NGLs were
available on the market, oil prices would have already
collapsed.
The final element contributing to paint a black picture for oil
producers either countries or companies
is the strengthening of the US Dollar, which increases the
producers spending power and discouragesinvestments in oil
futures.
Facing all of this, even the explosive geopolitical tensions
across the Middle East or at the Russian borders
seem no longer enough to support oil prices: This was the case
for a long time, but now only some newlarge-scale geopolitical
crisis like an attack by fundamentalists on a great producer or an
effective ban
on much of Russian exports could likely have this effect.
There are also other factors that might put a floor and even
cause a bounce-back of oil prices, such as a
generalized cut in investments by oil companies or a decisive
action by the Organization of PetroleumExporting Countries (Opec)
in terms of oil supply cuts.
The former factor calls into question not only the issue of
actual break-even costs of many global projects
but also other, less considered factors. In its turn, the Opec
issue requires a deep understanding of howthe current relations
among the Organization members stand.
I have a view on both elements, but it requires a few more pages
do deal with. As a consequence, itwould be the topic of another
newsletter over the next few weeks.
[email protected]
NOTES
[1]Maugeri, Leonardo. Oil, the Next Revolution. The
Unprecedented Upsurge of Oil Production Capacity
and What It Means for the World. Discussion Paper #2012-10.
Belfer Center for Science andInternational Affairs, John. F.
Kennedy School of Government, Harvard University, 2012. At:
http://belfercenter.ksg.harvard.edu/files/Oil-%20The%20Next%20Revolution.pdf
[2]Ibidem
[3]Ibidem. The study continued by observing that: A sudden dip
below $50 would not necessarilysuspend the development of many
projects worldwide, but would only slow their execution. The
exceptionwould be those projects that hold the highest marginal
costs, such as some Canadian tar sands projects,
Venezuelan extra-heavy oils, Brazilian pre-salt formations, as
well as those projects that can be stoppedimmediately, such as U.S.
shale/tight oil ones those of OPEC producers, whose execution
depends on thewill of governments.
Such a response from oil companies and governments would soon
curtail new production, leaving theworld market vulnerable to
sudden disruptions by geopolitical factors or major accidents once
again.Furthermore, market instability would likely coincide with a
rebound of oil demand, driven by lower prices.
Market forces should then realign prices with the higher
marginal production costs in less than two years.[4]Ibidem
[5]See, in particular: La Fed fa bene al prezzo del greggio.
Ecco perch ci sono le condizioni per la finedel superciclo delloro
nero. (Fed action is good for the price of oil. Thats why there are
the conditions forthe end of black gold supercycle) In: Il Sole
24-ore, December 24, 2013. At:
http://www.ilsole24ore.com/art/notizie/2013-12-24/la-fed-fa-bene-prezzo-greggio-064152.shtml?uuid=AB6hXul&fromSearch.
See
Oil Crash: Why I Was Right - Harvard - Belfer Center for
Science...
http://belfercenter.ksg.harvard.edu/publication/24653/oil_crash.html?b...
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