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Dave Summers

Dave Summers

David (Dave) Summers is a Curators' Professor Emeritus of Mining Engineering at Missouri University of Science and Technology (he retired in 2010). He directed the…

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Don’t Expect Low Oil Prices To Last For Long

Don’t Expect Low Oil Prices To Last For Long

When I last wrote about the global supply of oil, it was back in October, as the fall in oil prices was developing. Since then the price has continued to fall, with prices now below $60 a barrel. I was doubtful back then that the price would fall as far as it has, and remain cynical that it will remain down for very long. Since this seems to go against much current wisdom, let me explain why I remain pessimistic that the boost to the global economy from access to cheaper fuel will continue for any great length of time.

It depends on whose data you believe regarding how much more supply than demand there currently is in the market. When looking at the numbers in the past I used a number of roughly 1 mbd, but this is hard to realistically quantify. Why – well the problem comes with the regions of the Middle East and North Africa (MENA) where there are current conflicts. The ones of particular concern are Libya and Iraq, although the fluctuating state of exports from Iran cannot be neglected. When the Libyan conflict first impacted the export of oil from that country Saudi Arabia began increasing its production to offset the loss in Libyan exports.

Related: The Hidden Costs Of Cheap Oil

There came a time in September when Libyan exports, which had fallen to around 300 kbd from a high of over 1.6 mbd, shot back up to around 900 kbd. The EIA has recently shown an inverse correlation between Libyan production and oil price:

Brent Oil Price and Libyan oil production (EIA )

Figure 1. Brent Oil Price and Libyan oil production (EIA )

Thus, when an additional 600 kbd suddenly appeared back in the marketplace, it is not surprising that it had an impact on prices. However while there was already some surplus in the market (from increased production in the US etc, which I will comment on below) the volume of the addition had a more significant impact on prices, and when KSA decided not to reduce production this led the market to assume that we had returned to plentiful sufficiency, and prices have continued to fall since.

However, this perception is already unraveling. The Libyan conflict has continued to embroil their oil fields. The Sharara field, which produces 300 kbd closed in November as fighting overwhelmed it. At the moment two of the oil export terminals are threatened, and with them another 300 kbd of oil. But it is not possible, at this point, to predict what is going to happen in either location. There is little sign that the conflict is any closer to resolution, meaning the production will continue to be threatened into the foreseeable future. Sadly it is more likely that this will have a negative impact on oil production, so it might be wiser to assume lower rather than higher volumes coming from the country.

The situation is a little clearer and more optimistic in Iraq, where the pipeline through Kurdish territory has lessened the impact of the Islamic State take-over of a large swath of the country. The recent agreement between the Iraqi Federal Government (IFG) and the Kurdistan Regional Government (KRG) approved early this month is already raising questions over the volumes that the KRG will put onto the market. The agreement calls for sales of around 550 kbd, but there is an additional 100 kbd that is available, the status of which is unclear. The country is exporting, overall, around 2.51 mbd and the pipeline to Turkey is currently carrying 280 kbd, but is being boosted to carry 400 kbd, with an ultimate throughput of 700 kbd. Part of the problem in assessing the market for this, however, in the short term is that the Iraqi crude is often heavier and of relatively lower quality than the market average. This is currently causing some marketing problems, leading the IFG to lower prices in order to find a market. In neither case, however, is the current conflict likely to impact the production for export, and while it is difficult to anticipate much production above 3.5 mbd. (The December OPEC MOMR suggests that they are producing 3.36 mbd at the moment) we are unlikely to see any significant reduction in production going forward. The significant growth in global production to meet a still predicted rise in demand next year (albeit down slightly from previous estimates) will, therefore, not come from OPEC, who still anticipate that they will produce, on average 400 kbd less than they have this year. It is still expected that American production will continue to rise to meet expectations of increased global demand.

The problem, unfortunately, with that view, is that increases in US production are tied to output from fracked horizontal wells that are expensive to drill, and have a relatively short production life, with the majority of production coming in the first year of operation. Thus, in order to sustain production, more wells must be drilled each month to cover the loss in production from existing operations. The North Dakota Department of Mineral Resources projects that 225 or more drilling rigs are needed to sustain the growth of production from the state over the next three years (at which time it will plateau at around 1.5 mbd). Presently there are roughly 180 rigs operating, with the count falling by the week, as the rewards, at present, do not match the cost. The agency anticipates that the number will fall by an additional 40-50 rigs by the middle of next year. Well completions are also falling by the month, as the industry likely plans to wait out the current hiatus in prices. The impact of this on even short term production should not be discounted. There has already been a slight fall in production, rather than a gain, in October, and that will likely accelerate.

Related: How Will US Fed React To Low Oil Prices

Without any gain in production, and in fact, the potential for a drop in US production over the next year, then the anticipated surplus between oil supply and demand will likely disappear. Remember that the MENA nations are seeing growth in their internal demand for oil (in the KSA this has already passed 3 mbd) so that if they had no impetus to reduce production and exports in the face of falling prices, so they are unlikely to increase production when prices pick up. They haven’t before.

When will this all happen? Well I got the size of the price fall wrong, so don’t hold me to the exact timing, but I would anticipate that when we see the start of the driving season next year, the oil market will tighten rather quickly. Following that and given the inertia in getting production back in the US, we will, as I have been expecting for a couple of years, see the global concern over supply start to be a significant factor in 2016.

By Dave Summers

Source - http://bittooth.blogspot.mx/2014/12/tech-talk-gentle-cough.html 

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  • DPlatt on December 16 2014 said:
    Radical Islam is seizing oil fields and refineries to support their takeovers (caliphate). Has me wondering if NATO is cutting them off. Nearly every single one of T.Boone Pickens videos on youtube point this out (GET RID OF OPEC). Try a google search for "OPEC IS DEAD".
  • John C. Sipple on December 17 2014 said:
    Well written article. I'm in the oil business -Independent producer. I've been in the business for 38 years. Your numbers are right on.

    I think that what it boils down to is that Saudis are smart enough to get rid of the 1 million barrel per day increase in oil production coming out of the U.S. Push the price down to the mid 50s and hold it there for at least 9 to 12 months = no increase in year over year production coming out of the U.S. Demand is still going up and will go up even more with the price in the 50s. Supply and demand will tighten and yes the price will gradually start to go back up in late 2015 - early 2016 - barring a war in the middle east. Also - This puts some reality back in the U.S Oil Business. The small independents were borrowing money and drilling like the price would never go down (remember housing and real estate?)
  • John Scior on December 17 2014 said:
    I think it is important to note in the analysis of oil prices one must consider the vast importance of Federal reserve actions. When speculators and investors are wishing to preserve wealth, and in view of the unprecedented creation of dollars, a tidal wave of money gets invested in oil and other commodities. Now , we see the money creation machine has been turned off, the flow out of these commodities has sprung forth. This article does good justice to explaining the supply and demand for oil, however in the background one should also consider the supply and demand for dollars in price determination.
  • Gene Frenkle on December 17 2014 said:
    Saudi Arabia is just as concerned about losing market share to natural gas as it is to shale oil. The US has huge natural gas reserves and at $100 barrel CNG and LNG vehicles and electric vehicles powered by natural gas power plants would start making inroads. US airlines would begin investing in gas to liquids for kerosene and the U.S. oil market would get smaller every year. The U.S. would also begin exporting LNG to the Caribbean which displaces oil and piped natural gas to Mexico displaces oil and allows Mexico to export more oil.
  • Snake Oil Baron on January 03 2015 said:
    The main motivation of the Saudis is that they are parked on a blurry edge between a cold war and a hot war with Iran and Russia. They are pissed at what they see as Russia's multi-front war on Sunni Muslims with the Syrian genocide being the biggest and last straw while they understand that the thing to fear about Iran isn't their strength or potential future strength but their unstable unpredictability. They don't trust Iran with nukes and all parties know that the match between Iran's missiles and Saudi Arabia's air force favors whoever strikes first.

    The Saudis know that Iran and Russia hurt more from low prices than they themselves do and are hurting from other factors already.

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