Global oil markets may be on the verge of a crippling new market crash, as analysts looking back on a major price drop earlier this month survey a landscape of declining investment in some parts of the industry, combined with rising production in U.S. shale fields that still seem incapable of satisfying investors by turning a profit.
The picture could shift at any time, and in any direction, with much of the in-the-moment analysis (no doubt including ours) tending to reinforce the authors’ hopes or expectations for future energy markets.
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“Oil prices are falling, and analysts and market players are as eager as ever to explain the decline in accordance with their own bullish or bearish leanings,” writes consultant Irina Slav for Oilprice.com. “It’s a natural correction that was only to be expected after the buildup of long bets on crude oil and oil product futures, the bulls insist. It’s the start of a trend, thanks to the major jump in U.S. production, the bears counter.”
But now, “data from physical oil markets has surfaced that supports the bears’ stance,” she adds, reinforcing the sense that fossils and their backers are in for more turmoil and angst.
Reality on the Ground
Slav distinguishes between the speculative markets where future oil prices are set and the physical markets “where actual oil is taken from one place and shipped to another to be refined into fuel and other products.” She adds that “if the physical market points down, chances are the price drop—15% in three weeks—is not just a blip.”
“Physical markets do not lie,” said Michael Tran, managing director of global energy strategy at RBC Capital Markets. “If regional areas of oversupply cannot find pockets of demand, prices will decline.”
Slav also cites a warning from the International Energy Agency that another oil oversupply is not out of the question this year—despite determined efforts by the Organization of Petroleum Exporting Countries (OPEC) to limit production and clear a long-standing surplus in global oil markets, thereby driving up oil prices.
“The main factor is U.S. oil production,” the international agency stated, acknowledging that a production surge that has been widely touted by U.S. fossil hawks spells trouble in the world markets on which that production ultimately depends. “In just three months to November, crude output increased by a colossal [846,000 barrels per day], and will soon overtake that of Saudi Arabia. By the end of this year, it might also overtake Russia to become the global leader.”
The Next Price Crash: Oil Pays the Price
In a separate post for Oilprice.com, Pittsburgh energy and climate freelancer Nick Cunningham agrees that another downturn for oil might be in the offing, citing a Bloomberg interview with CMC Markets analyst Ric Spooner. “Oil is paying the price for rising too quickly to levels that attracted increased U.S. production,” he said. “Traders are also nervous about recent financial market volatility and the stronger dollar.”
While some of the recent price drop might trace back to normal ups and downs in investment markets, Cunningham points to data from the U.S. Energy Information Agency that indicate continuing production growth in U.S. shale fields. The EIA’s projection that output will hit 11 million barrels per day, a year earlier than expected, is making analysts nervous about a new oversupply—even as investment houses like Goldman Sachs point to more modest spending and drilling plans from shale producers.
In early February, before the latest price drop, Goldman predicted the price of benchmark Brent crude oil would hit $75 per barrel in three months and $82.50 by August.
The New York Times notes that the surge in U.S. production gives the country and the bombastic occupant of its highest elected office more than bragging rights. “The results go far beyond the economic, offering Washington strategic weapons once unthinkable,” the paper states. “The United States and its allies now have a supply cushion at a time when political turmoil in Venezuela, Libya, and Nigeria is threatening to interrupt flows to markets.”
‘OPEC Missed the Point’
In contrast to the 1970s, when the first OPEC oil embargo sent the U.S. economy into a tailspin, “the new energy power also relieves pressure on Washington to act militarily if tensions between Iran and Saudi Arabia break out into war. And it gives Washington the leeway to apply sanctions on other producers—as it has in Russia, and may in Iran or Venezuela—with far less risk to the global economy.”
“OPEC missed the point,” former OPEC secretary general and one-time Ecuadorean energy minister René Ortiz told the Times. “They thought they could recover the U.S. market by bringing the prices down. Now the U.S. has gained the leading position in the world oil market regardless of what OPEC does.” He added that “this displacement of Saudi oil, Nigerian oil, Libyan oil, and Venezuelan oil was never anticipated.”
The Times notes environmentalists’ worry that low oil prices will artificially extend the life of the fossil economy. “Concerns over climate change as well as the growing popularity of electric cars and the eventual aging of the best shale fields will probably curb production and demand over the next few decades,” writes reporter Clifford Krauss. “But in the short term, the boom has changed the landscape.”
Booming Production, Spooked Investors
But so far, at least, the industry’s optimism hasn’t shown up in its financial bottom line. After the initial oil price drop in early February, “some highly disappointing numbers from a few oil majors made things worse,” reported the Nasdaq stock exchange, in a post picked up by the Institute for Energy Economics and Financial Analysis (IEEFA). “ExxonMobil and Chevron, in particular, spooked investors when they revealed fourth-quarter earnings that badly missed expectations” from analysts, by 40% at Chevron and 15% at Exxon.
“The disappointing numbers were, in part, the result of a slump in refining margins,” Nasdaq stated. But it added that Exxon’s oil and gas extraction operations would have lost money, too, if not for the big, $190-billion gift fossils received through Donald Trump’s tax overhaul in January.
“One way to put these earnings in perspective: Exxon is depending on rising global prices to earn a profit while having increasing difficulty in translating higher oil prices into higher profits,” wrote IEEFA’s Tom Sanzillo and Kathy Hipple. “For long-term investors, this was Exxon’s twelfth consecutive quarterly loss in its U.S. drilling business.”
Oilprice.com’s Cunningham, meanwhile, unearthed an analyst report in January that levelled similar criticisms at U.S. shale producers, contending that the highly-touted industry segment still isn’t profitable, its costs are rising, its much-celebrated efficiency improvements seem to be a mirage, and its drillers are pursuing “irrational production.”
“Despite rising prices, most firms under our study are still in losses with no signs of improvement,” concluded Riyadh-based Al Rajhi Capital, with average return on assets sitting at “a measly 0.8%”. The cost of producing a barrel of shale oil has been rising, Al Rajhi found, and as of the third quarter last year, average operating cost per barrel has broadly remained the same without any efficiency gains.
While the study acknowledges that shale production costs have “edged down over the past several years,” Cunningham writes, “a broader measure of the ‘cash required per barrel’, which includes other costs such as depreciation, interest expense, tax expense, and spending on drilling and exploration, reveals a more damning picture,” with costs steadily rising to a threshold of $64 per barrel late last summer.
Fossils Pressured by Surging Renewables
And as if the challenges for the industry weren’t steep enough, Communications Director Silvio Marcacci at Energy Innovation notes on The Energy Collective that falling renewable energy prices are pushing fossil-generated electricity ever farther from profitability (and will soon have the same effect on liquid fuel demand and prices).
“Rapid cost declines made renewable energy the United States’ cheapest available source of new electricity, without subsidies, in 2017,” he writes. “Despite Trump administration actions to improve fossil fuel economics and reduce renewable energy competitiveness,” clean energy “continues beating fossil fuels on economics, at a faster pace and in more locations than ever before.”
How low can renewable energy prices go? “Unfortunately for fossil fuel advocates, renewable energy is expected to keep getting cheaper and adding more capacity while coal, nuclear, and natural gas costs are forecast to remain stagnant and lose ground in the overall power mix,” Marcacci writes. Meanwhile, “fossil fuel generation will hold steady or even increase,” according to data from the U.S. National Renewable Energy Laboratory.
New Fossil Discoveries Hit Record Low
Potentially countering the price pressure on fossil producers, analysts at Rystad Energy reported late last year that discoveries of new conventional oil reserves hit a record low in 2017, at only (so they said) seven billion barrels or equivalent (boe). That’s still a huge quantity of new oil and gas that will have to stay in the ground in any realistic decarbonization scenario, but the number still points to an industry decline: “We haven’t seen anything like this since the 1940s,” said Rystad Senior Analyst Sonia Mladá Passos.
The data also showed fossils discovering significantly smaller volumes of new hydrocarbon resources in each of the new fields they identified. “Low resources per discovered field can influence its commerciality,” Passos said. “Under our current base case price scenario, we estimate that over one billion boe discovered during 2017 might never be developed.”
That may reflect the longstanding reality that many fossils are now pushing ever farther into riskier, more remote regions to get at deposits that are less convenient and productive than the ones they’ve now tapped out. But Passos also noted that “global exploration expenditures have decreased year over year for three consecutive years now, falling by over 60% from 2014 to 2017.” She warned that supply shortages could loom a decade from now without “a turnaround in this trend”.
But fossil energy fund CEO Adam Waterous said oil prices would have to hit Goldman Sachs’ aspirational threshold of $80 per barrel for at least two years to justify the turnaround Passos was calling for. “And even then, it could take a decade before crude from those investments would arrive on the market,” Bloomberg reported, in a pre-crash week when crude prices hit a high of $66 per barrel.
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