Got volatility!? The topic du jour is crude oil. As I write this article, West Texas Intermediate oil prices are $75/bbl, Brent is below $80/bbl, and the collective energy business is holding its breath after OPEC failed to cut production quotas during its Nov. 27 meeting. We have not had to worry about a cut since 2009, and OPEC watchers are coming out of the woodwork. The reality, unless you have Saudi oil minister Al-Naimi’s cell phone number, you are just another member of the OPEC guessing club.
OPEC—wait…what? Now that we have established that forecasting OPEC is out of my pay grade, let’s talk about the oil markets beyond OPEC. We believe the oil markets will be oversupplied during first-half 2015, as partially restored Libyan oil production has not been offset by reduced Saudi output. This is setting the stage for lower oil prices during that time frame, if the market remains oversupplied. The adage that the best thing for low oil prices, is low oil prices, rings true as non-OPEC supply growth will eventually decline and help balance the market, with or without OPEC. Unfortunately, the supply reaction to lower prices takes time. Since the Unites States has accounted for almost all of the net growth in non-OPEC supply over the past few years, let’s take a look at what could happen to U.S. supply.
$70/bbl WTI. In a draconian case of $70/bbl WTI in 2015, we believe many of the ramping oil basins become uneconomic below $80/bbl, which will create a disincentive to drill new wells. Moreover, many E&P companies’ balance sheets, combined with lack of access to capital markets, will also create lower drilling activity. How much? We believe capital spending could be lower by more than 20% versus 2014, and rig count could decline by as much as 550 rigs, many of these currently drilling high-impact horizontal wells. Our baseline annual growth in 2015 and 2016 of approximately 800,000 bopd would be a lower growth rate of 500,000 bopd, and a paltry 100,000-bopd, year-over-year, addition in 2016. Interestingly, U.S. oil production in 2015 will grow in almost any scenario, with the growth front end-loaded during first-half 2015.
Silver lining? Yes, there is a silver lining in the dark cloud of reduced capital spending, lower rig count, and lower production growth. Remember that the U.S. accounted for almost all of the non-OEPC supply growth over the past few years. If U.S. growth flattens in 2016, there is no non-OPEC addition, and OPEC will be called upon to increase production in 2016 (if not earlier) to balance the market. Oil prices will rise, activity will return, and all will be well from Houston to Midland to North Dakota. The challenge is that oil production does not immediately respond to lower prices, it takes time. By mid-2015, activity restraint and lower production growth will be visible to the oil markets, creating optimism for 2016. But July 2015 will seem like a lifetime, if oil is $70/bbl.
Global pain! But wait! The U.S. isn’t the only oil producer exposed to low oil prices. What happens to the rest of non-OPEC supply? Russia produces 10.5 MMbpd, and low oil prices, combined with sanctions, should turn a slow-growth profile into declines in 2015 and 2016. Lukoil recently stated that if oil prices averaged $70/bbl or lower in 2015, capital spending will be down by more than 20%. Similar to the U.S., we would expect second-half 2015 production to be impacted, and in Russia’s case, output could fall in 2015, and again in 2016. By 2016, supply will show visible declines, and the growth trajectory of the rest of non-OPEC should be similar. This deteriorating, non-OPEC supply and demand growth will pressure OPEC to add significant barrels back to the market.
A word about demand. Global demand is difficult to forecast, yet the market tends to fight the last war. Slowing demand growth in 2014, and worries about China, translate into a perpetual negative state on demand. Remember demand decline in 2008 and 2009, as the world navigated through a financial crisis? Global demand fell a combined 1.5 MMbopd during that period, yet rebounded in 2010 with a whopping 2.9 MMbopd of growth! Even during periods when global demand grew, just more slowly (as in 1998 and 2001-2002), demand rebounded nicely in the following year (up 1.7 MMbopd in 1999 and 2003).
A word about natural gas. We remain cautious on natural gas as storage filled this summer with record, or near-record, injections nearly every week, suggesting the market is 3 Bcfd oversupplied. The even worse news is that production growth should continue into next year, creating a scenario where near-term supply growth is not directly offset with future demand via LNG exports, U.S. demand growth (industrial and power sector), and Mexican exports. However, slower oil growth means slower growth in associated gas production (in 2016), which, combined with stronger Mexican pipe exports than we currently assume, could tighten the market in 2016, several years sooner than we expect. Hopefully we will be able to show off our newly sharpened “gas bullhorns” by the middle of 2015. In the meantime, we wish the northern tier of the U.S. a merry and cold holiday season! 
|
