Concerted production cuts by OPEC+ and IOCs have largely been canceled out by a sharp fall in global oil demand from a record peak of >100 mbd to a recent low of 70 mbd, while WTI prices appear stuck in the mid-$30/barrel range. Given this backdrop, the last thing on the minds of investors probably is the prospect of the oil markets doing a 180 by going from a supply glut to a supply crunch. Still, it’s worth taking a look at this through a contrarian lens that reveals the unexpected: An oil supply shock is not as far removed from the realm of possibility as we might imagine.
Here are some scenarios that would take us from a world awash with black gold to one where pumps start running dry.
Falling Oil and Gas Capex
Source: NS Energy
The epic oil price collapse has triggered a wave of huge E&P Capex cuts by the majority of oil and gas companies. Analysis from Rystad Energy shows that global capital expenditure (capex) spending by exploration and production companies is likely to fall by $100bn this year to around $450bn--a 13-year low--as oil and gas operators prioritize liquidity with many trying to maintain the all-important dividend. U.S. shale producers are set to lower Capex by ~30%
Mind you, that’s in a base case scenario where oil prices average $34 per barrel through the year; a worst-case scenario could see capital outlay dropping to $380bn in 2020 and just $300bn in 2021.
While those are huge cuts by any yardstick, they still fail to convey the full story: Global E&P capital spending has consistently remained way lower than levels recorded during the early part of the last decade. Related: 5 Points To Consider Before Buying Oil Stocks In 2020
At a time when the U.S. shale industry was going through a phase of a debt-fueled drilling frenzy, the rest of the oil world entered into a “Lower Forever” mindset in the famous words of Royal Dutch Shell PLC’s chief executive Van Beurden and started to seriously trim spending. Capex investments across the globe crashed 66 percent between 2014 and 2016 to $322 billion and have never fully recovered. Global E&P Capex spending in 2019 clocked in at an estimated $546bn, well below the $880bn recorded in 2014 during the last oil price boom. The latest spending cuts have set back the clock a good 13 years. Obviously, it’s just a matter of time before global production starts to suffer. Roughly 60 percent of the world’s oil comes from just 25 oil fields mainly in Saudi Arabia and the Middle East with an average age of over 70 years and already experiencing 6-7 percent annual declines. Further, the role of Saudi Arabia as a swing producer tends to be overstated, with its often-cited spare production capacity of 2.5mb/d closer to 0.5mb/d.
How critical is the lack of sufficient capital investment in determining future supply?
In 2018, the International Energy Agency (IEA) released a report dubbed the New Policies Scenario wherein it answered this question.
According to the global energy watchdog, oil supply would drop by over 45 mb/d if no capital investment into existing or new fields was made between 2017-2025. Even continued investments into existing fields but with no new fields being brought online--aka the “observed decline”– would still lead to a decline of close to 27.5 mb/d over the forecast period. Even assuming global oil demand falls by 10 mb/d in the post-COVID-19 era would still leave a huge 17.5 mb/d supply-demand gap.
This suggests that production could be materially affected if Capex remains at the current levels for another 2-3 years.
U.S. Shale Pullback
With most oil-producing countries in terminal decline or having plateaued, U.S. shale is the new swing producer and the biggest wildcard in the global oil markets. In the IEA report, U.S. shale was slated to bridge about a third of the supply-demand gap by providing 11mb/d of tight crude oil, tight condensates, and tight NGLs. The sector has already announced 30 percent Capex cuts and could see production fall by 2mb/d in 2020. Most shale producers in the Permian and Eagle Ford need $46 a barrel on average to drill new wells and $51 in the Bakken.
The shale fracklog has already started depleting after falling 10 percent last year, the first drop since 2016, and a clear signal that explorers are finally slamming the brakes on drilling activity. With a huge wave of well shut-ins still going on, U.S. shale could permanently lose 10 percent of production in existing wells even after they are re-opened.
According to the IEA report, since 2014, the global average level of resources approved for drilling for new conventional crude oil projects each year has been closer to 8 billion barrels, or about half of what is required to fully meet global demand by 2025. The same report estimated that US tight liquids production would need to grow an additional 6 mb/d by 2025, roughly equivalent to adding Russia’s production to the global oil balance over the next 7 years, to meet the shortfall.
Even recalibrating the supply/demand dynamics due to the crisis suggests that a fast recovery of U.S. shale will be required to prevent serious supply shocks a few years down the line.
Ultimately, the global oil trajectory will be dictated by how quickly oil demand recovers as economies emerge from lockdown. However, if it turns out that we have truly entered the era of ‘Forever Low’ and current oil prices become the new norm, oil investments will definitely suffer and then it’s a matter of time before we start to see a serious supply crunch.
By Alex Kimani for Oilprice.com
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