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Nick Cunningham

Nick Cunningham

Nick Cunningham is an independent journalist, covering oil and gas, energy and environmental policy, and international politics. He is based in Portland, Oregon. 

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Global Oil Supply More Fragile Than You Think

Global Oil Supply More Fragile Than You Think

Many oil companies had trimmed their budgets heading into 2015 to deal with lower oil prices. But the rebound in April and May to $60 per barrel from the mid-$40s suggested that the severe drop was merely temporary.

But the collapse of prices in July – owing to the Iran nuclear deal, an ongoing production surplus, and economic and financial concerns in Greece and China – have darkened the mood. Now a prevailing sense that oil prices may stay lower for longer has hit the markets.

Oil futures for delivery in December 2020 are currently trading $8 lower than they were at the beginning of this year even while immediate spot prices are $4 higher today. In other words, oil traders are now feeling much gloomier about oil prices several years out than they were at the beginning of 2015. Related: Don't Expect An Oil Price Rebound This Side Of 2017

The growing acceptance that oil prices could stay lower for longer will kick off a fresh round of cuts in spending and workforces for the oil industry.

“It’s a monumental challenge to offset the impact of a 50% drop in oil price,” Fadel Gheit, an analyst with Oppenheimer & Co., told the WSJ. “The priorities have shifted completely. The priority now is to discontinue budget spending. The priority is to live within your means. Forget about growth. They are now in survival mode.”

And many companies are also recalculating the oil price needed for new drilling projects to make financial sense. For example, according to the Wall Street Journal, BP is assuming an oil price of $60 per barrel moving forward. Royal Dutch Shell is a little more pessimistic, using $50 per barrel as their projection. For now, projects that need $100+ per barrel will be put on ice indefinitely. The oil majors have cancelled or delayed a combined $200 billion in new projects as they seek to rein in costs, according to Wood Mackenzie. Related: EPA’s Clean Power Plan Tougher Than Expected

But the delay of 46 major oil and gas projects that have 20 billion barrels of oil equivalent in reserves mean that global production several years from now could be much lower than anticipated. Due to long lead times, decisions made today will impact the world’s production profile towards the end of this decade and into the 2020s. It makes sense for companies to cut today, but collectively that could lead to much lower supplies in the future.

That is a problem because the oil majors were struggling to boost oil production even when oil prices were high. 2014 was one of the worst in over six decades for major new oil discoveries, even though oil prices were high for most of the year. Despite high levels of spending, exploration companies are simply finding fewer and fewer reserves of oil.

Shale production has surged in recent years, but it could be a fleeting phenomenon. Precipitous decline rates from shale wells mean that much of a well’s lifetime production occurs within the first year or two. Moreover, after the best spots are drilled, the shale revolution could start to come to a close. The IEA predicts that U.S. shale will plateau and begin to decline in the 2020s. That means it would not be able to keep up with rising demand. Add in the fact that oil wells around the world suffer from natural decline rates on the order of 5 percent per year (with very wide variation), and it becomes clear that major new sources of oil will need to come online. Related: Campaign 2016: Where Are The Candidates On Energy?

One other factor that could tighten oil markets over the long-term is the fact that Saudi Arabia has churned through much of its spare capacity. As one of the only countries that can ramp up latent oil capacity within just a few weeks, Saudi Arabia’s spare capacity is crucial to world oil market stability.

Many energy analysts like to compare the current oil bust to the one that occurred in the 1980s. But one of the major differences between the two events is that, in addition to the glut of oil supplies in the 1980s, was the fact that Saudi Arabia dramatically reduced its output from 10 million barrels per day (mb/d) down to less than 4 mb/d in response. As a result, on top of the fact that the world was awash in oil throughout the 1980s and 1990s, there were also several million barrels per day of spare capacity sitting on the sidelines, meaning there was virtually no chance of a price spike for more than a decade.

That is no longer the case. Today OPEC has only 1.6 mb/d of spare capacity, the lowest level since before the 2008 financial crisis. So while Saudi Arabia is currently flooding the market with crude, it has exhausted its spare capacity, leaving few tools to come to the rescue in a pinch.


That brings us back to the large spending cuts the oil majors are undertaking. With spare capacity shot and major new sources of oil not coming online in a few years, the world may end up struggling to meet rising oil demand. That could cause oil prices to spike.

By Nick Cunningham, Oilprice.com

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Leave a comment
  • valuecat on August 05 2015 said:
    Refreshing to see a balanced view of crude prices....something that is sorely lacking in financial media. I'm in the camp of what can't continue won't, but I certainly could forsee a relatively flattish period of oil pricing through the balance of 2015. I challenge anyone who has done any sort of due diligence on U.S. energy companies cost structures to make a case for $50 oil going forward. As John McEnroe used to proclaim..."you cannot be serious!"
  • Tim Schmidt on August 05 2015 said:
    Oil market commentators, of which you are one, keep saying that prices are low in part, because of weak demand. Then two paragraphs later you tell us that we will run short because of rising demand. You can't have it both ways. Which is it?
  • Bob on August 05 2015 said:
    An important, interesting and well written article.
  • Jim on August 06 2015 said:
    Is Iran in OPEC, because I believe that they have a good deal of spare capacity. How about Iraq and Libya? Nigeria? Venezuela? That's not to mention Mexico and Brazil. The problem in nearly all of these countries is politics. When you write of spare capacity, perhaps you should specify immediate capacity not impeded by unpredictable government interference. Getting oil to market is the issue, not spare capacity.
  • Richard on August 06 2015 said:
    Oil will continue to experience downward pressure as long as Saudi Arabia keeps producing at record levels. Other issue too is how many Shale producers go back online when oil reaches $60 mark. So oil will not rebound much past $60 and could see $40 or even $35 oil in the meantime especially with weakening Chinese growth. Also nobody is speaking about the Chinese housing bubble that could burst at any moment. Furthermore the only reason oil supplies were down this report is because refineries are purchasing at record levels to capitalize on the cheap oil. The issue there is gasoline stock piles were up 800,000 barrels which only means the reduction in crude is not true to consumption. Bearish oil is here to stay until at least 2017 unless Saudis cut production.
  • Luís on August 07 2015 said:
    Petroleum extraction peaked in Russia (either in 2013 or 2014, depending on whom you ask). Five years from now Russia will be clearly in its decline phase from its top petroleum extracting country in the world today. Most analysts still do not count with this.
  • JP Franklin on August 08 2015 said:
    I guess the whole deal about 97% of reputable scientists warning of catastrophic climate change if we do not stop burning fossil fuels is of no importance to speculators and others trying to get rich from oil. Greed blinds to reality. Is there another explanation?
  • Gary on August 09 2015 said:
    We have lost over 1,900 rigs world wide, much of that is the USA. The production decline curve never sleeps, and always wins. All the speculators in the world can not change the laws of physics. We are already at the flat top and will soon head down the production curve. Oil is an inelastic commodity so a 2% glut has caused a 60% drop in prices. Likewise, a balanced market, or even a slight shortage will allow the speculators to once again run amuck in the financial markets.

    Worldwide, wells decline at 5% per year, but shale production is declining at about 6% per MONTH !!!!!! After a couple years, shale wells are dead. That is why we have half the rigs in the world operating in the USA.

    I can't tell you how severe the decline will be, but I can tell you it has begun. Nat Gas has already made a noticeable decline. Oil will be next.
  • Greg on August 09 2015 said:
    Many Countries are just starting their own fracking ,seeing US success. Could it be significant addition to the glut on a short run?

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