Will stability become the new watchword for the oil market?

Will stability become the new watchword for the oil market?

Some believe that US shale production will end the market’s boom-bust cycle

The oil world is divided into two camps.

There are those who believe the crude price will eventually spike higher, repeating the boom-bust pattern that has defined the market for more than a century. Lined up against them are those betting prices will defy history, staying low and rangebound.

Three years into the price slump precipitated by the growth of US shale, the “lower-for-longer” crowd appears to be winning. Oil has been stuck near $50 a barrel for most of 2017 and prices for crude deliveries years in the future are little higher, suggesting few are anticipating a significant recovery.

Complicating the debate is that it hinges on a US shale industry that is barely a decade old and accounts for little more than 5 per cent of global supplies. Can it really eliminate the risk of a price spike by growing fast enough to meet forecasts for rising demand?

“The view that prices are going to stay low forever is a stunning statement,” said Jamie Webster at the BCG Center for Energy Impact. “To go from what we have had since the 1860s to that situation in just three years is a big step. You are arguing that there will be effective oil market stability because of a truly competitive market.”

When the downturn began in 2014, the world was forced to reckon with ballooning US supplies. But even today, the shale industry is unfamiliar territory with hedge funds, oil companies, Opec countries and even shale producers at odds about the future.

Being right matters. Oil prices dictate not only how much resource-rich nations earn from crude sales but also how profitable some of the world’s biggest energy companies are, affecting future investment in production as well as security of supply.

Those confident prices will remain within a band close to today’s levels believe in the ability and agility of US shale oil companies and other unconventional producers to ramp up output as needed. The opposing faction says the retrenchment in investment since the downturn will create a supply shortfall just as demand expands, driving up prices.

“Shale has consistently surprised with its resilience,” said Jason Bordoff, director at the Center on Global Energy Policy at New York’s Columbia University. “Still, we’re only in the first few innings of the shale revolution, and there remains uncertainty about [its] magnitude and longevity”. 

Of total global production at about 98m barrels a day, US crude output makes up 9.2m b/d with the country’s fast-growing shale segment comprising just 5.6m b/d, energy data show.

The mismatch is why drastic cuts to investment in future production have forced global energy bodies and exporter countries, such as Opec’s de facto leader Saudi Arabia, to warn of a looming supply gap.

Historically about 15bn barrels of new supplies from conventional resources are approved for development each year, the International Energy Agency says. This fell to 8bn in 2015 and 5.5bn in 2016. Despite a rise to 8bn-9bn barrels this year, the IEA expects that global oil supply will still struggle to keep pace with demand after 2020.

Global oil consumption is expected to grow on average by 1.2m b/d each year to 2022. The IEA’s forecasts also account for unconventional supplies as well as declining output rates from existing fields.

Tim Gould, the IEA’s long-term supply analyst, accepts that US shale supply could increase “significantly” from today’s levels. “But after that, large scale increases will be difficult to achieve. There is less of a chance that it can ramp up to fill any gap.”

Proponents of this view, including hedge fund manager Pierre Andurand, say oil will return to $100 a barrel.

But those confident the price will stay rangebound are not convinced. The fear — or hope — of an emerging supply gap is exaggerated, they say, and fails to acknowledge shale supply as a transformational force.

“The oil market is indeed the most competitive it has ever been,” said Ed Morse at Citigroup, who argues that US shale has broken the historically oligopolistic market structure.

Rather than Opec’s production determining market balances, US shale is the new source of responsive supply. Mr Morse argues the shale deniers are underestimating its prowess, from the geology to the technology allowing this oil to be unlocked.

“There is just an unwillingness to understand shale. It’s a world that many still find alien,” said Mr Morse, who believes $45-$65 oil is likely to persist for years.

US shale producers have reduced their costs by more than a third, become more efficient and hastening their lead times. While costs are rising again, inflation is limited to well completion rather than drilling, and productivity gains are rapidly rising.

Forecasts about peak US shale production vary greatly but the general consensus is that it could double by 2025 with oil prices between $55 and $60 a barrel, analysts at broker PVM say.

Those pushing the lower-for-longer — and maybe forever — thesis also question the willingness of Opec producers and their allies to maintain supply curbs as production from the US to Canada’s oil sands and Brazil’s deepwater fields thrives. Compared with those focusing on robust demand from emerging economies, oil bears are turning attention to when consumption peaks as climate policies, electrification of transport and a global shift towards renewables further hurt oil use. Unquestionably, US shale’s resilience has enabled it to surpass even the most bullish expectations. But Bob McNally at consultancy Rapidan Group said the industry had yet to prove itself as a “swing producer”, able to put a floor as well as a ceiling on prices. Volatility, he said, is the only certainty. “Perpetual $50-$60 is as wrong now as endless $100 was four years ago.”

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