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Oil supply reductions to potentially push up crude prices amid fundamental sector challenges

The oil industry faces political and financial uncertainty as global production is curtailed to prop up the volatile price of crude.

The price of crude was down 1.26% today to US$51.78 with brent also down 1.11% to US$60.73

Following peaks above US$100 a barrel in mid-2014, the oil industry witnessed a sharp and sustained drop in crude prices, reaching as low as US$25 a barrel at the beginning of 2016.

The past year has given optimistic signs to industry participants and investors, with the price slowly climbing to above US$75 a barrel at the end of September.

However, substantial price fluctuations throughout 2018 and a steep drop in the December quarter to just above US$40 a barrel suggest further catalytic price activity can be expected.

Intrinsic volatility of sector

Pwc’s report ‘Oil and Gas Trends 2018-19’ noted the intrinsic volatility of the sector as its fundamental challenge, saying “oil and gas companies must develop a resilient strategy to mitigate [market and new energy transition] risks”.

The report’s authors foresee a supply crunch for oil and gas which would potentially put upwards pressure on prices.

Deloitte’s 2018 oil industry outlook sees the year’s price recovery a result of the ongoing production restraint agreement between OPEC and non-OPEC and continued strong global oil demand growth.

The Energy Information Administration estimates global oil demand growth was about 1.6 million barrels a day in 2018.

Production cuts to lift prices

OPEC met in mid-December and agreed to cut 1.2 million barrels a day starting in January in response to the global oversupply.

The producing economies hope that production curtailments will drive prices higher, despite US shale production steadily increasing.

Responding to the growth in US shale oil production concurrent with falling investment in conventional sources, the International Energy Agency (IEA) refers to a ‘two-speed oil market’.

In their World Energy Outlook 2017, the IEA said “the world needs to find an additional 2.5 million barrels a day of new production each year, just for conventional output to remain flat”.

Source: BP Energy Outlook 2018 


Potential price recovery

In their biannual Global Oil Supply and Demand and Outlook, McKinsey predicted average oil prices to stay in the US$60-70 a barrel range if current geopolitical uncertainties subside and OPEC increases production.

Prices could potentially go as high as US$80-90 per barrel, according to McKinsey, if existing supply disruptions such as Venezuelan production cuts or sanctioned Iranian exports continue.

Oil production in Venezuela has come down to about 1.5 million barrels a day, a 40% decrease from the 2.5 million barrels being produced in early 2015.

Libya is currently producing 990,000 barrels a day, down from the 1.5 million barrels being produced in 2012.

Political and financial catalysts

A factor of significant importance to the oil price in 2018 has been the turbulent geopolitics emanating from Washington.

US President Donald Trump’s decision to reimpose sanctions on Iran in November before changing tack and providing waivers on Iranian oil exports caused prices to surge and then plummet.

Trump’s tweets directed at OPEC, as well as the unresolved trade dispute with China, have also caused a degree of uncertainty across markets.

Another important consideration for oil in 2019 and beyond is the potentially disruptive growth seen in the electric vehicle and battery space.

The BP report Energy Outlook 2018 notes this key uncertainty depends on several hard-to-predict factors, such as government policy, technological improvements and social preferences.

Other potential developments such as bans on internal combustion engine (ICE) vehicles or disruptive battery and energy technologies could potentially cause further volatility.


Supply-side challenges

While supply is generally being curtailed, Pwc pointed out several supply-related challenges such as the ongoing decline in new discoveries.

The report said: “By the end of 2017, the volume of new oil and gas discoveries was its lowest since the early 1950s.

“To put this into perspective, only 3.5 million barrels of liquids (crude, condensate and natural gas liquids) were discovered in 2017, which was enough to meet only 10% of demand.

“The reasons for this decline are simple: it’s getting harder to find the large discoveries known as ‘elephants’ and most prospective areas have already been explored.”

A second challenge, according to the report, is the subdued growth in exploration spending since the price collapse in 2014-16.

“Globally, spending fell by more than 60%, from a high of US$153 billion in 2014 to about US$58 billion in 2017.

“It is forecast to recover modestly over the near-term at a 7% compound annual growth rate.

“The investment slump in traditional supply sources looks like it will continue to have an effect on new production.

 “Given that it takes about three to six years from project sanctioning to coming onstream, the decline in investment approvals during the price slump could continue to hurt the sector if financial investment decisions remain constrained.”

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