The media is full of stories predicting that the oil price will go over $100 a barrel within a year or two while others predict “lower, longer” prices. Odd as it might seem, both are possible depending primarily on what happens in certain oil producers, especially Iran and Venezuela, as well as Libya and Nigeria. All these countries are suffering from political problems of different sorts, and each could see either a recovery in production or further disruptions.
But this also reflects a tendency towards superficial views of the market. This was made obvious when the price of oil was over $100 a barrel and many executives argued that the marginal cost of production was $100, so that the price could not be below that for any length of time. Such is simply untrue: lower prices would mean expensive projects would be abandoned, reducing the apparent marginal cost, and lower investment would reduce upstream costs, which had been seriously inflated for cyclical reasons.
Still, several market watchers have argued that 3 mb/d of planned projects have been cancelled or delayed by the 2014 price collapse, and the IEA has noted that upstream investment has dropped by about one half from 2014 to 2016. There has been some recovery, but investment is still about 1/3 below the peak, and international drilling is lower by roughly the same amount (figure below).
New supply does not just occur in large increments, but often in relatively small-scale drilling especially in existing fields. Low levels of upstream investment does mean that these fields’ production will decline more quickly, higher investment and the decline will slow, meaning net supply change will be higher. The IEA estimates decline rates in existing fields, and believes that the rate has slowed in the past year, from 7% in 2010-2014 to 5.7% in 2017, meaning a net supply gain of about 600 tb/d per year.
And while there have been concerns about bottlenecks in both the Permian oil field and Western Canada oil sands operations, causing some operators to suffer from double-digit price discounts, the argument that this will curtail supply over the long term appears misplaced. Pipeline capacity in the Permian is growing and Canadian producers, relying on rail shipments for now, have continued to increase production to record levels.
The figure below shows the annual growth rate for non-OPEC supply predicted in each of the IEA’s past five medium-term outlook compared to the actual rate from 2013-2018 in million barrels per day. It appears as if the current IEA forecast is much too pessimistic about supply from Canada, Russia and the U.S., while slightly too optimistic about Mexican supply, although Mexican reforms could reverse that.
Which brings us back to the current market tightness. The collapse in Venezuelan production has taken roughly 1 mb/d off the market in the past year and should continue, while new U.S. sanctions against Iran could remove a further 1 mb/d or more of supply. However, most of this has already been offset by increases from Saudi Arabia, Russia and others and appear unlikely to increase much beyond the end of this year. Indeed, a new government in Venezuela could easily restore significant amounts of supply with moderate amounts of maintenance and repair, although when that will occur is hard to say.
There remains, as always, the threat of further supply problems in a variety of countries but after a prolonged period of widespread disruptions, these should ease over the next five years—on average. Price spikes (and crashes) are still likely but overall, the market should be well-supplied. I think prices for Brent should average around $70/barrel or lower, with changes in production from Iran and Venezuela especially moving them up or down accordingly. The potential for robust increases from Iraq, Russian and the U.S. could make OPEC (or at least the Saudis) decide that the equilibrium price is below that level.
Source : HSN