peacefare.net

There is a great deal of uncertainty in oil markets at the moment.  The big questions, beyond when the market will rebalance, include:

• Are we in the midst of another boom and bust cycle in the oil market or are there structural changes that define a new paradigm?  Has U.S. tight oil changed market dynamics forever?
• Has the Saudi/Iranian rivalry evolved to the point where geopolitics now dominates Riyadh’s approach to oil?  Are the Saudis using oil as a weapon?
• Is the Saudi 2030 Vision OPEC’s “obituary notice” as some have declared?  Will the Saudis continue to invest in oil or are they pumping all out now due to concerns that oil demand is going away?
• Are we in a “lower for longer” scenario for oil prices?  Or have the large cuts in investment by oil companies in the past couple years simply planted the seeds for the next price spike?

As we think about these questions, and more importantly what the future of oil geopolitics might look like, it is helpful to ground ourselves with a few facts.  It is important to remember:

• The countries of the Persian Gulf account for almost 1/3 of global oil production and hold roughly 50% of proven oil reserves.  They generally have the lowest cost oil to produce.
• About 17 million barrels a day (mbd) of crude oil and refined products move through the Strait of Hormuz, only a small fraction of which could get to market via alternative routes if the strait was blocked.
• Oil fields have a natural decline rate averaging 3-6 percent a year, much higher for U.S. tight oil.  This means that every year investment in existing or new fields is needed to bring to market about 4 mbd of additional oil just to keep global production at current levels (not including any increase in demand).  Those 4 mbd are equivalent to the total surge in U.S. tight oil production over the 2011-14 period.  It also means we need to add the equivalent of a new Saudi Arabia to the market every 3 years.

By one estimate, global upstream project cancellations could create a 4 mbd ‘‘hole” in global oil supplies by 2020.  Estimates of production in Brazil, Canada, Mexico and elsewhere in coming years have been revised downwards.  There is growing concern that the large reduction in investment by the international and national oil companies will lock in the world’s reliance on OPEC, and in particular on the lower-cost supplies from the Persian Gulf, for decades.  The International Energy Agency (IEA) and the U.S. Energy Information Administration (EIA) have pointed to this risk in their most recent global energy outlooks.

Are there structural issues that might mitigate against greater reliance on OPEC and the Persian Gulf?  Two are often cited – the U.S. tight oil boom and climate change.

U.S. TIGHT OIL:  While U.S. tight oil production jumped by an average 1 mbd per year from 2011 through 2014, over the past year U.S. tight oil production is down about 1 mbd.  In the meantime U.S. gasoline consumption has increased sharply and is expected to hit a record in 2016.  So U.S. oil imports are growing again.  Last year U.S. net crude oil imports dropped to only a quarter of U.S. consumption, the lowest level since 1970.  This year it looks like we will need to import one-third of our oil.  Some believe that with prices of $50 or more per barrel there could be a renewed surge of U.S. production this year adding perhaps as much as 1 mbd to U.S. output by the end of the year.  But that is a very optimistic scenario.  And after that?  There is no doubt U.S. production could resume an upward climb with higher prices, but almost certainly not enough to offset reduced output elsewhere in the world.

CLIMATE:  All scenarios that would reduce carbon emissions enough to keep global warming to 2 degrees or less require a huge shift away from petroleum for transportation.  Both Statoil and the IEA have modeled what very aggressive introduction of electric vehicles (EVs) might do to oil demand, in the case of Statoil’s “renewal” scenario new car sales would be 90 percent EVs or hybrids by 2040.  Even with such an enormous change in how light duty vehicles are powered global oil demand would still be in the range of 75-80 mbd by 2040 — as much as 20 mbd below today’s consumption but still requiring very large investments to compensate for the decline of existing fields.  Supply could well decline much faster than demand.

So what does this all mean for the U.S. and the world?

• We are not in a new paradigm.  Oil is not going away and the world’s dependence on the Persian Gulf for global supplies is very likely to increase going forward.  Therefore the U.S. will need to play an active role in the region to ensure the oil keeps flowing, including protection of sea lanes.
• U.S. “energy independence” remains a chimera even if we were self-sufficient in oil, which is very unlikely to happen in any case.
• OPEC is not dead.  Notwithstanding the Saudi/Iranian rivalry, they are likely to be able to and want to work together to influence the oil market once markets are more in balance.  Recent statements by the new Saudi oil minister indicate they will continue to invest heavily in maintaining their production capacity.
• We need to keep our eye on the ball regarding constraining oil demand – continued progress on more efficient vehicles, facilitating the move to EVs, to natural gas for trucking, etc.
• Innovation is essential (e.g., autonomous vehicles), ideally in cooperation with international partners.
• We should continue to encourage and assist new and non-OPEC oil producers seeking to boost their output, in particular Mexico and emerging suppliers in Africa.
• We should not be treating our Strategic Petroleum Reserve as a piggy bank – selling off oil to meet other budgetary requirements.  We may need the SPR to cushion a supply disruption, U.S. tight oil is not a substitute.  At the same time we should continue to promote cooperation by China and India with the IEA on a coordinated response to an oil supply disruption given their increasing importance to the market (and since they are building their own strategic reserves).