The International Energy Agency (IEA) released its Oil 2019 report March 11, providing forecasts to 2024. The IEA paints an extraordinary picture of transition for the oil industry, but it is not the 'energy transition' driven by climate change; the impacts on the oil market of policies designed to mitigate climate change appear relatively weak over the next five years. The seismic changes illustrated by the IEA are those wrought by the US shale industry.
The IEA's former narrative on US shale was that once it had burst upon the scene it would eventually burn itself out in the mid-2020s. The sweet spots would be exhausted, marginal costs would rise as oil became harder to locate, and more oil would constantly have to be found to replace the level of decline from wells drilled during the expansionary phase, eventually making it impossible to sustain growth - essentially the classic path of a conventional oil basin.
To a large extent this story remains in place, but it is also clearly under constant re-evaluation, the problem being that the depth and longevity of US shale is not known and remains a function of price and productivity - which means the ultimate recoverable reserve should be treated as elastic rather than finite.
If a bell curve in the style of Marion King Hubbert were used to predict US shale oil production, 2018's mammoth expansion would have moved the predicted peak higher and further back in time, resulting in a significantly larger area representing…
The International Energy Agency (IEA) released its Oil 2019 report March 11, providing forecasts to 2024. The IEA paints an extraordinary picture of transition for the oil industry, but it is not the 'energy transition' driven by climate change; the impacts on the oil market of policies designed to mitigate climate change appear relatively weak over the next five years. The seismic changes illustrated by the IEA are those wrought by the US shale industry.
The IEA's former narrative on US shale was that once it had burst upon the scene it would eventually burn itself out in the mid-2020s. The sweet spots would be exhausted, marginal costs would rise as oil became harder to locate, and more oil would constantly have to be found to replace the level of decline from wells drilled during the expansionary phase, eventually making it impossible to sustain growth - essentially the classic path of a conventional oil basin.
To a large extent this story remains in place, but it is also clearly under constant re-evaluation, the problem being that the depth and longevity of US shale is not known and remains a function of price and productivity - which means the ultimate recoverable reserve should be treated as elastic rather than finite.
If a bell curve in the style of Marion King Hubbert were used to predict US shale oil production, 2018's mammoth expansion would have moved the predicted peak higher and further back in time, resulting in a significantly larger area representing the total volume of recovery.
This is shown by the IEA's forecast for total North American liquids production, which is expected to reach 26.9 million b/d in 2024, 800,000 b/d higher than that forecast for 2025 under the IEA's New Policy Scenario in its 2018 World Energy Outlook published only last November. This sizeable revision underlines that it is still too early to treat US shale as a conventional oil basin.
A second major uncertainty, stemming from the IEA's focus on oil in this report, is the linkage between oil and gas production, which complicates any assessment of shale's marginal economics.
According to the IEA, by 2024, shale oil will be by far the largest component of US liquids production at just below 10 million b/d, but second to that will be the expansion of Natural Gas Liquids (NGLs), which will reach some 5.5 million b/d, much of which is the product of natural gas processing.
The huge expansion in US LNG capacity is another side of the same coin. The pipeline of major new projects has started to refill in earnest since the Autumn of 2018, with North America leading the way. Providing new avenues for shale gas monetisation supports the US shale oil sector in what is almost a classic case of industrial symbiosis, to which can be added ethane and gas use in the refining and petrochemicals sectors.
Investment narrative
If the IEA's narrative on US shale is in a constant state of flux, so to perhaps should be its narrative on energy sector investment. Didn't it repeatedly warn of an impending oil supply gap - the inevitable result of the sharp drop in oil and gas sector investment that followed the oil price crash in 2015?
Oil and gas markets do not appear to be suffering a lack of investment. This is partly because oil prices are proving relatively buoyant as supply is restricted by a range of non-market forces - the collapse of Venezuelan production, sanctions imposed by the US on Iran and Venezuela, the expansion of OPEC's reach through its cooperation with Russia and the determination of Saudi Arabia to curb production.
In Oil 2019, the IEA does not just cite the US as a source of future oil supply growth, but Iraq, the UAE, Guyana, Brazil, Norway and perhaps most significantly for the longer term shale oil in Argentina. This is a much broader suite of growth sources, particularly non-OPEC, than has been the case over the last decade.
It implies a weakening of OPEC's ability to manage the market through production controls, or alternatively that it will have to pay a much bigger price to do so. This will intensify the organisation's internal strains as both Iraq and the UAE may be thwarted from reaping the full rewards of their expansions by having to bear more of the responsibility for market management.
The investment story for refining appears no different. The IEA outlines an expected expansion in refinery capacity double that of the expected increase in demand for oil products. This is a scenario in which there must be losers.
The refining sector is an oddity, suffering from endemic over-capacity as a result of the logic followed by both oil consuming and producing nations; both see every reason to capture the refining margin. For the producer this adds to its value chain, for the consumer it offsets the cost of its supply chain, particularly if it can also export oil products, a position China is moving resolutely towards.
Both can protect their investments; crude producers by providing a supply of cheap feedstock for their refineries; importers by restricting access to their product markets. This is why refinery expansions take place in regions where feedstock supply is growing on the one hand and in regions where oil product demand is increasing on the other.
The losers will be those without cheap feedstock and without domestic market growth - Europe, OECD Asia - while African refining is also likely to continue to struggle.
Refineries are also strategic assets and governments are loath to see capacity shrink to levels that endanger security of oil products supply. This tends to sustain refinery lives, resulting in either upgrades to become more competitive, as oppose to closure, or, as the IEA notes, an increase in 'phantom' refinery capacity - capacity which exists but cannot commercially be used.
As a result, for crude oil supply, LNG and refining, investment levels appear to leave the IEA searching for a new narrative of doom.
This it will certainly find. IEA warnings that energy sector investment is too low is the one constant the oil market can depend upon. A lack of investment eventually means higher prices and the IEA's prime purpose as the representative of net energy importing countries is to keep energy prices low, so it will always find a way to issue these cautions.
But the argument is currently difficult to sustain. The answer will be to push forward in time to the mistier period beyond 2024, when the impacts of that other energy transition - the climate change one - might be much harder felt and the leftfield risks of oil sector myopia all the more profound.