The US Shale Oil and Dwindling Oil Prices – Is it another Episode or a Permanent Shift?

Dr. Salman Ghouri & Dr. Yumna Ghouri (published in OilVoice on January 26, 2016)

Just to refresh our memories of 1970s, 1980s, 1997, and 2008 and now in 2015 what differences can be observed? Are we expecting similar trends – rising and falling of oil prices? Or would it be different this time around due to the unconventional revolution? Those who were born during 1970s may not be aware of the oil price shocks of 1970s and its consequences. The press was full of articles related to “Peak oil”, “The end of cheap oil” and some pictures of that time can be seen below. 

 Some pictures – 1970s oil price crisis

The world was in the healing process when it was hit by another shock of 1979/80. Oil prices had increased from $14/bbl to over $35/bbl, an increase of 150%. The event of 1979 further cemented the wisdom of peak oil theory for general public at large, though causes were of the Iranian revolution. Just to remind some of the readers, oil prices had collapsed to below $10/bbl in 1986! Why? OPEC increased its production in an effort to defend its depleting market share that has been under severe pressure on account of rising non-OPEC production. Other intervening shocks were Iraq-Kuwait 1990, Asian financial crisis of 1997 and aftermath of 9/11, war in Iraq, civil unrest in Nigeria, strikes in Venezuela, mighty Katrina, Middle East crisis - events that happened during the period of 2000 to 2006. We can still recall what had happened during 2007/2008, oil prices continuously arose, peaking in mid July at $147/bbl. The wisdom of some consultants, and many analysts were again influenced by current events and they were anticipating that oil prices increase to over $150 or even some were of the view of $250/bbl is a possibility! What happened in the 2^nd half of 2008? Oil prices collapsed to below $40/bbl despite OPEC cutting its oil production twice. It was April of 2008, and I was speaking at the International Research Center for Energy & Economic Development (ICEED) as the only speaker in the conference was of the view that oil prices were going to collapse while other speakers suggested it to be increasing. Speakers and delegates did not buy my argument which were based on the basic economic fundamentals. The reason being that generally people are influenced by most recent events/prices. Oil prices did decline as I had predicted and after a short duration, it slowly recovered and stabilized around $100/bbl. Oil producers were enjoying the bounties of higher oil prices and OPEC members lavishly increasing the government expenditures for the welfare of their people as well as wisely accumulated sovereign funds for rainy days.

 

Oil prices 2009/2015 – Structural Shift?

The period of 2007 to 2015 is what I call structural changes in oil and gas industry. Though unconventional industry was slowly progressing, it flourished and nurtured at the lap of higher and sustained oil prices during 2009/2015.  The sustained higher oil prices of over $100/BBL that provided a breathing space to the industry, allowing it to develop and master innovative technology (horizontal drilling, hydraulic fracturing, multi fracturing, less use of water etc) and was well supported by favorable policies of various States.

In 2012, I wrote an article entitled: “The US Unconventional Revolution are we at the beginning of a new era for US oil?” was published in European Energy Review June 18, 2012. Based on my analysis I suggested to OPEC that “It could be in the interest of OPEC to already increase its production now and allow oil prices to decline to below $60 to discourage further development of shale oil”. Have OPEC missed the train. Looking back yes and now maintaining its oil production in an effort to defend market share and discourage shale oil boom – trying to kill two birds with one shot. Such strategies will only end up hurting them as circumstances have quite a bit changed. OPEC needs to develop a compromising strategy, remove lavish energy subsidies, impose income taxes (people may not like the idea but this is reality), learn how to live in lower oil price environment, downward adjusting break-even prices and adopt diversification policies for sustainable economic growth.

Generally peoples’ perceptions are influenced by most recent trends in oil prices. Currently oil prices are low and, therefore, one could see the press is full of articles and most of the papers/articles are talking about oil prices of $20/bbl or even $10/bbl. Yes, it is quite possible given the current situation of booming US shale oil, higher inventories, higher expected oil supplies from Iran and weaker global oil demand are favoring lower oil prices. The question however is for how long? Are these lower oil prices of $10/$20/$30/bbl sustainable over extended period of time?  

In my personal view, even though the world will not be the same as that of 2009/2015, the world will also not be the same as of thirties or twenties oil. Why? The reason is that lower oil prices will discourage further investments in upstream as well as will be difficult to make much needed investment that is required to sustain current level of production. Another factor of dwindling oil prices is stronger dollar. The question is for how long dollar continue to dominate and its sustainability over extended period of time. US economy cannot continue to flourish when other global economies are on the decline. Beside companies will be suffering losses and that will affect the supply side over the longer period. For example, The debt of ExxonMobil (XOM), Shell, Chevron (CVX), and BP (BP) rose from $75 billion in 2008 to $155 billion at the end of 2014. As of June 2015, these companies owed $176 billion. Eventually, these companies are going to have to pay this money back. And with them already reducing capital expenditures (a broad measure of how much energy companies spend to find oil and gas) and trimming operating costs that money will have to come from somewhere else... like the funds currently used to pay dividends. In addition, a number of companies will vanish and file bankruptcy – a loss of production though these companies will be acquired by other smart investors. The lower oil prices on the other hand will facilitate the economic recovery of many OECD countries and other emerging and developing countries. “Cyclical Oil Prices – Is it a Necessary Condition to Balance Global Oil Supply/Demand?”
Due to structural shift in oil & gas industry the duration of current episode could be extended over one to 12-18 months and eventually oil prices will bounce back to around $50-60/bbl (red line in graph). In addition, the penetration of electric  and fuel cell cars is the reality of today and will significantly reduced demand for oil in transport sector within the next decade or so. That is oil industry will not be the same of over $100/bbl. Therefore oil companies need to develop a new strategy to be successful in new challenging low oil price environment
 

 

 

Dr. Salman Ghouri Oil & Gas Advisor (Geopolitics | Economics | Development)

 

 Note: you can access this paper on oilvoice website as well. 

http://www.oilvoice.com/n/The-US-Shale-Oil-and-Dwindling-Oil-Prices-Is-it-another-Episode-or-a-Permanent-Shift/f08beb7ab57e.aspx#.VqeNLzSk-GE.linkedin