Permanent Pricing Pain?

Of course, nothing lasts forever, least of all reserves of crude oil. However, at present, US shale (or “tight”) oil production, particularly in the Permian Basin (where there is something of an acreage acquisition frenzy continuing) is seen, whether accurately or not, as the global swing producer, usurping the long-standing role played by Saudi Arabia.

The Saudis and OPEC tried to destroy the opposition by driving down prices to what were considered unsustainable levels for the US shale oil industry, only to see that backfire by decimating their own budgets. There was a winnowing of marginal players in the US, as the level of bankruptcies and restructurings over the past 2 years or so amply demonstrated. However, the attempt at destroying the US competition signally failed, as producers retrenched, adapted their business models, significantly improved their technology and operations and reduced their breakeven levels.

Consequently, OPEC tried to re-group and enforce discipline by setting production quotas in an attempt at least to put a floor under prices. Perhaps surprisingly, the quota restrictions were largely observed. However, as OPEC (led by Saudi Arabia) and Russia try to extend the programme they face dissension, as well as the fact of more production from Libya and Nigeria; while, naturally, the “undisciplined” Americans revert to ramping up production, as rising rig-counts amply demonstrate.

Couple this with uncertainty about the level of demand in the near term (let alone the longer term impact of factors such as the rise of electronic vehicles, and renewable energy sources) and one has the makings of further volatility in crude oil prices, but this time to the downside rather than the upside, as those who forecast such things reduce their pricing expectations below the USD 50 per barrel level, with nadirs into the USD 30/bbl range.

All of this points to continuing budgetary pain for the majority of oil producing “petro-states”, for whom oil revenues generate the majority of their tax revenues. Even the mighty Saudi Arabia is considered to have a “breakeven level” closer to USD 70/bbl before it can balance its budget.

And budgetary pain has social and political consequences, particularly in the “brittle” systems that govern many of the world’s petro-states, because few if any of them have equipped their societies to deal with the potential end of the dominance of hydrocarbons as the key energy source, even though Saudi Arabia’s new Crown Prince is at least trying.

If one were truly Machiavellian, one might even wonder if the attempt to squeeze and disrupt the economy of Qatar was a ploy to create sufficient uncertainty about its own 600,00 barrel per day output to bolster oil prices.

It is also somewhat ironic that the ending of the decades-old prohibition on the export of US crude oil towards the end of the Obama administration probably contributed to the current pricing environment, because it introduced a new source of crude oil exports onto the world market.

So, at Awbury, we would be circumspect in anticipating any major upswing in crude oil prices in the near to medium term. Yet we recognize that, because of all its variables, choke-points, animosities and sheer complexity, being “certain” about that outcome is a mug’s game. Therefore, as always, we factor multiple scenarios into our assessment of any hydrocarbon-related business, because the historical record amply demonstrates that being wedded to any one view will almost certainly not end well.

The Awbury Team

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