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Don’t Expect Low Investment To Raise Oil Prices
In the late 1980s, some people in the oil industry were said to have bumper stickers reading, “God give me one more boom and I promise not to mess it up.” (When the price was over $100, I joked about people investing in bumper stickers.) With the recent recovery in oil prices to $50 a barrel, and soaring investment in the Permian, voices can be heard warning that shale producers are threatening to ‘mess it up’ again, while others warn that the decline in upstream investment will lead to tight markets in 3-5 years. In fact, this theme originated in the post World War II era with British petroleum economist Paul Frankel who described the industry as prone to cycles of over- and under-investment. (My mentor, Morry Adelman, disagreed, stating that over-investment seemed the norm.)
During my four decade career, complaints from various sectors of the industry regarding insufficient price levels have been near constant. Tanker owners, drilling service companies, and oil producers have argued that higher prices were needed to justify investment, or else shortages would occur within a few years. Some have gone so far as to argue that customers should offer higher prices to enable them to be healthy enough to invest for the expected boom years. Unsurprisingly, when costs soar, none are willing to offer discounts to their customers.
As the figure below shows, global drilling has declined since the price fell. But the drop in upstream investment is temporary and should not cause a significant market tightening. When company revenue crashes, they have a rapid reduction in capital expenditures, but as they get their balance sheets in order, a bounce back occurs. Last year, Wood Mackenzie estimated a reduction of as much as a trillion dollars of investment over five years, about 30-40%, but much of that will be offset by cuts in rig services. And Douglas Westwood has projected deepwater spending this year will be roughly at 2013 levels.
Offshore Drilling Rigs
There is a fine line between irrational exuberance and wishful thinking, but from bankrupt shale producers to struggling companies like Chesapeake Energy, the cost of believing bad price forecasts was clear. Many assumed large debts in order to invest in resources they expected to provide a strong payout in future years, which required those prices to remain high. Aubrey McClendon even argued that shale gas was high-cost and thus necessitated high natural gas prices, a misunderstanding of the relation between costs and prices that cost him and his company.
He was hardly alone. When oil prices were $100 a barrel, a chorus insisted that the easy oil was “gone” and the high breakeven cost necessitated that prices not decrease below that level for any length of time. One CEO even suggested in 2012 I was an idiot for thinking that the long-term price was likely to be $50-60 per barrel.
Most oil company executives, if asked, will explain that naturally prices have to rise in the long-term and the vast majority of forecasters would agree. For example, the U.S. Department of Energy predicts prices rising to $91/barrel by 2025 and $141 by 2040 while the International Energy Agency sees them going to $80 by 2020 and rising gradually thereafter.
What few realize is that the throughout the history of the oil industry, the price, adjusted for inflation, has averaged roughly $30/barrel, going significantly above that level only when political disruptions of supply caused the market to tighten, as in the past decade.
Higher costs have occurred in the past decade, but as a result of higher prices, not the need to look for oil in more extreme environments. When prices rise, so does investment and faster than the service industry can respond. Instead, equipment and personnel costs inflate. But this is a cyclical effect, and reverses when prices, and activity, decline as we are now seeing.
There has been a focus on the recent surge in costs in the U.S. shale industry, but this is hardly a return to pre-bust cost levels. And globally, costs remain lower, offsetting much of the decline in investment. The figure above shows offshore drilling levels and they have clearly dropped sharply since the price came down in 2014; however, as the following table shows, much of the change has been in a few countries, notably Brazil, Mexico and Angola. The first two should recover shortly as legal issues are resolved, with or without a “recovery” in prices.
Drop in Drilling Rigs Since February 2014
| LAND | OFFSHORE | |
| TOTAL | 282 | 118 |
| BRAZIL | 20 | 14 |
| MEXICO | 53 | 24 |
| ANGOLA | 15 | |
| NIGERIA | 6 | |
| INDONESIA | 11 | |
| MALAYSIA | 10 |
The other offsetting factor is the likelihood of significant new supply from Iraq and, later, Iran, which will be relatively cheap. Mexico, Brazil, Guyana, offshore West Africa and onshore east Africa, plus Norway and U.S. shale oil will all be adding large increments over the next five years if prices are “only” $50 a barrel. Only serious supply disruptions from political events would likely keep prices higher.
64 Comments on "Don’t Expect Low Investment To Raise Oil Prices"
Boat on Sat, 25th Mar 2017 6:10 pm
Mak,
Who are these Americans that claim we do not import from around the world. Me thinks your full o shyt. You and Trump full o fake news. Lol
onlooker on Sat, 25th Mar 2017 6:10 pm
Good Boat. let the Robots deal with peak oil, climate change and the rest of the shitstorm coming ourcway
GregT on Sat, 25th Mar 2017 6:19 pm
“Good Boat. let the Robots deal with peak oil, climate change and the rest of the shitstorm coming ourcway”
Somebody would actually have to invent “The Robots” first.
makati1 on Sat, 25th Mar 2017 6:20 pm
Boat, you and Davy are so delusional and uninformed…(uneducated? Over medicated? Brainwashed?) Do you need me to name names or did you read all of the comments and know whom I am talking about?
Davy on Sat, 25th Mar 2017 6:31 pm
You know you are hitting on all cylinders when all makati can do is say a few empty disparagements. Makati you are just upset because I have bitch slapped you good lately. That is not hard to do to someone like you who is a fake and a blowhard.
GregT on Sat, 25th Mar 2017 7:45 pm
“So tell me greggiet, why does greed have anything to do with it.”
Just basic human nature Boat. If not for greed the world wouldn’t be in so much trouble.
Boat on Sat, 25th Mar 2017 8:04 pm
Maybe basic human nature has more animal spirits when it comes to reproduction. Civilization and education and tech can breed those impulses into better decisions and responsible actions. This has much more impact and the potential impact than this greed you complain about.
GregT on Sat, 25th Mar 2017 8:44 pm
“Civilization and education and tech can breed those impulses into better decisions and responsible actions.”
Hasn’t happened yet. After several thousands of years of ‘civilization”, the best that humans have been able to come up with is a system that destroys their one and only ever planet as quickly as possible, in order to turn a fast profit. It doesn’t get any more greedy than that. Not to mention murdering hundreds of thousands of other people in order to steal their resources.
onlooker on Sat, 25th Mar 2017 8:53 pm
Yes. Civilization and technology overseen by us humans has been temporarily beneficial to some but spectacularly hazardous to everyone over the long term ie. future generations and the young now
makati1 on Sat, 25th Mar 2017 9:37 pm
ANYONE who lives totally off of another’s sweat and labor is a leech. Doesn’t matter how the blood is transferred. The West designed Capitalism to do just that. The 1% only exist because of the system. They are the greatest vampire leeches on humanity and the cause of its downfall and coming extinction. The only positive is that they too will die.
Boat on Sat, 25th Mar 2017 11:14 pm
greggiet,
Interesting trump won an election on the idea of more balanced trade. Even Steven stealing. For OCED countries population growth has slowed dramatically with countries like Japan, Russia dropping populations. Someday countries will brag about balanced or dropping populations along with talking about robot intensity that made it possible.
Also between tech and a growing awareness of climate many countries are making strides towards a cleaner energy profile. None of this happens without profit. China, Mexico, India and even the US have joined Europe on the path of using renewables to cut coal or energy that historical would have come from coal. The continued drop in renewable pricing, scale and efficiency will create world wide growth IMO will eclipse most growth predictions. You like to call it greed, I call it capitalism at it’s best.
GregT on Sat, 25th Mar 2017 11:50 pm
Are you by any chance a drug addict Boat?
Davy on Sun, 26th Mar 2017 12:30 am
“ANYONE who lives totally off of another’s sweat and labor is a leech.” makati, you earned the right to your social security stipend through your capitalistic employment now you are receiving a living off others sweat that means you are a leach by your definition. You are a global 1%’er and especially so among the many dirt poor of the Philippines. You are one of the 1BIL well to do. This means you are also a hypocrite. You can’t complain and blame about capitalism, leaches, and 1%er’s when that is what you are..ya but but…
GregT on Sun, 26th Mar 2017 12:37 am
Trump won the election because the American public are fed up with the status quo, and Hillary Clinton is a liar and a criminal.
That would be OECD countries, and the Russian Federation is not a member. Japan and Russia combined make up less than 5% of the world’s population. Overpopulation is a global problem, and the world continues to add another Houston Texas worth of people every 9 days, or 80 million each and every year.
Robot intensity? WTF are you on about?
The Paris climate accords were a dismal failure. Much ado about nothing, and the one country responsible for ~20% of the world’s emissions just tore apart the EPA, and is pulling all the stops on further oil and gas exploration/production.
Coal is masking climate change, and many within the scientific community consider natural gas to be a bigger contributor to greenhouse gas emissions than coal.
Alternate electric power generation is not going to replace oil. Growth requires energy. We are heading into a reduced energy future, not an increased energy future.
I like to call a spade a spade. Capitalizing on others, and on the Earth’s natural biosphere are both completely unnecessary, and are totally driven by an insatiable appetite for more. AKA: Greed.