No one has any idea what 2016 will bring, but that has not stopped 192 million people from taking a crack at predicting it, according to a quick Google search. It should be safe to say that in the energy business, we are going to see a fascinating collision between new found religions and cold hard truths.
Rather than pay attention to predictions, which will sound smart or dumb depending on how close they are to your beliefs, it’s more useful to consider which viewpoints are currently the most prevalent. These are the viewpoints that often dominate the news and are taken to be truths, and are then reflected in futures markets which as we know drives capital flows and market sentiment.
As we hobble into 2016 (an producer-centric description compared to consumers who are loving current oil prices), there is now a fairly broad consensus that production can be kept almost flat with minimal capital requirements even if prices remain low. This is because of the shale revolution, enhanced drilling productivity, and reduced costs. That’s what forward markets are saying.
Is it true? Time will tell. But, let’s pull our head out of today’s news sites and the one-dimensional story, and look at things from a global perspective. Or even a historical one: energy markets have a history of wild swings in prices and production, the business is always booming or busting. Exciting plays come and go. For example, North Dakota recently enjoyed (if being overrun is enjoyable) a massive boom that strained infrastructure and saw tens of thousands of people move to the region as part of the shale revolution. Few people recall that the exact same thing happened in North Dakota 50 years ago. Plays boom, wild forecasts are made, and the truth always falls somewhat short of the hyperbole. The Canadian oil sands were going to flood the market, but the environmental footprint is unbearable for modern energy romanticists, and no one can build a pipeline to get the stuff out anyway. Brazil’s subsalt deposits were going to save the day – except not really, the cost is too high, the play is complex, and politics are way too involved.
How about more exotic locales like Kazakhstan? Oil discoveries over there created a lot of waves and took a lot of capital, but was no global savior . What about places like Iraq? Lots of oil, but…would you like to go develop those fields? The list goes on and on, large deposits that might have changed the energy world, but never did. Libya. Yemen. Venezuela. The North Sea. All added a few percent to global production, but no one global deposit this side of Saudi Arabia’s Ghawar field has had a major impact on global production. So when we hear how the shale revolution has redefined the industry, it helps to keep things in a global context.
Time and time again large new discoveries get all the news, except they are harder to find now and it’s harder to move the needle. On top of that, development capital is drying up rapidly. So as global oil and gas investments shrink, where will the oil come from to keep up with declines, never mind demand growth?
Another way to look at it: at $100/bbl oil and 92 million bbl/d of production, $9.2 billion was flowing into the hands of producers every day, or $3.3 trillion every year. At $40 oil that annual number falls to $1.5 trillion, meaning $1.8 trillion has disappeared from the budgets of producers. (Of interest: this number is actually much larger, because debt and equity markets are not so keen to play in the energy sandbox anymore. New capital, which is the lifeblood of energy production, is gone too. But for the point of this discussion it’s not even necessary to account for that). These are gross revenue numbers, much of which goes to governments, operating costs, etc. Those commitments remain, meaning that out of the $1.5 trillion of revenue remaining, much will go to governments and to pay operating costs.
One pillar of economic study standing the test of time is that increased prices will bring increased production. This principle holds especially true for oil and gas because many fields have been mapped out for decades but uneconomic to produce. Canada’s oil sands are the clearest example; the staggering reserves number (an estimated 1.8 trillion barrels in place, with a wild guess of 170 billion barrels being recoverable) has been known since the 1970s but it took high prices to begin developing it. And the same principle applies all over the world, including the current poster child – US shale deposits.
Now consider the impact that high oil prices had on production. Remember that oil prices never exceeded $40/barrel as a monthly average until 2004, and seldom went below after that. According the the IEA, 2004 global crude production (including NGLs and condensate) was 83 million bbl/d. By 2015, that number climbed to only about 93 million bbl/d. From 1986-2003, WTI averaged $21/barrel. From 2004 to the end of 2014, WTI averaged $78/barrel.
Even assuming flat production of 83 million b/d from 2004-2014, the world produced just over 30 billion barrels per year or 300 billion barrels over the 10-year period. The incremental revenue added by this production ($57/barrel) works out to…$17 trillion of additional revenue from higher prices alone. Even baseball pitchers don’t earn that.
One could argue where that money went, but it’s safe to say that a lot of it went to hydrocarbon development. Call it half. And the upshot is: It took $8.5 trillion, plus whatever was raised in debt and equity markets, to increase global production by a net 10 million bbl/d after natural declines. A recent article on BOE Report confirmed that OPEC is warning along similar lines.
With oil back to $40, consumption is growing again. Yet trillions are being removed from development budgets, and let’s face it, the world is getting a lot more picked over, geologically speaking; the days of discovering giant oil fields are pretty much over.
As with Canada’s oil sands, keep shale growth in perspective. Both are impressive natural reservoirs, but both need huge sums of money to develop, and both have trouble adding enough to move the world’s needle by more than a few percent.
Read more insightful analysis from Terry Etam here