This week the near term price for crude oil fell to -$37.68 per barrel. This was driven by the expiration of the May futures contract on the 21st of April and holders not wanting to take physical delivery of a 1,000 barrels of the commodity.
The world presently is ‘swimming’ in oil as we all know by now. For an ‘oilie,’ like me, it was just another fairly depressing day watching the industry in which I spent my working life implode. To improve my mood I shifted my thoughts to re-grounding in the overall thesis and direction I saw for oil in the future. Not the far-flung future where the world will run on moonbeams and daffodils, but just a short piece down the road. Perhaps two or three years. Are we still going to need oil and gas?
As discussed, anything related to oil and gas seems to be collapsing on a daily basis. Companies that are in the business of exploring for or producing hydrocarbons have seen their share price decline 50-95% in the space of just a few weeks. Some have filed for bankruptcy. Additionally the collapse of the global travel industry which uses a big chunk of the world’s output of oil, has also dominated the news over the last few months. What they have in common is that the root cause is the inventory builds and demand destruction from the coronavirus. Will this go on forever? We don’t think so, and now that we can see an end… sort of to this cataclysm down the road a ways, and are convinced there’s a tomorrow ahead for most of us, let now do some thinking ahead as what that may look like.
This year the population of the world will increase by about 80 mm people. In each succeeding year these incremental increases will continue. While Corona virus has turned out to be a train-wreck for the global economy, as we adapt to it, it’s not going to affect the upward trajectory of the rise in population by a measurable percentage. Factoid #1.
Just on sheer numerical increase alone this dark period we are passing through is… a blip. A mere snippet of time on the global chronometer. The simple reality is that in order to meet the basic energy demands of a world where the population goes from the current 7.8 bn to ~10 bn thirty years from now, we are going to need more units of energy, not less. Factoid #2.
Growth of the world’s middle class has driven energy use dramatically higher over the last decade. People like you and me use a lot of the stuff and most projections (here’s one as an example) show this sector of global population increasing by ~40% in the next decade.
It should come as no real shocker, I suppose that growth in the middle class by 40-50%, will lead to a commensurate increase in energy use. The EIA graphic below gives us an idea where this growth will occur. Factoid #3.
What will the role of oil and gas be in 2050? This is a natural question for discussion: will the current commodity collapse continue? Right now it appears to be heading irreversibly down. Perhaps surprisingly, it will be about what it is now on a percentage basis. The next graphic shows the direction of this commodity over the next thirty years. In absolute terms…oil and gas will have to deliver about 30% more BTU equivalents in 2050 than they now do. So let’s let that factoid sink in. In spite of all the renewable (solar, wind, biofuels) growth over this time, we will be using more oil and gas in 2050 than we do now. Significantly more. Factoid #4.
As a result of the growing population and size of the portion that is middle class, energy use will rise dramatically over the next 30 years. And, the portion of that energy supplied by oil and gas will be higher than it is now.
Less of it will be provided from shale going forward, though.
What happens with shale production over the next year?
The heyday of shale has passed, I think that is becoming painfully obvious to all of us. In its most recent report, the EIA is forecasting a drop of ~1.1-mm BOPD in shale by the end of 2021. I think they are wildly optimistic and actual total U.S. production will be under 8 mm BOPD by the end of 2020.
- The most recent survey of energy execs in the area served by the Dallas Fed, is fairly pessimistic as regards prices that would keep them in business. This shows that prices would essentially have to triple to keep most shale drillers in business. Nobody is really expecting a recovery of that magnitude in time to be of any help to these folks.
- Shutting in production. Now under discussion from a regulatory aspect. Marginal operators are closing in wells as costs of productionexceed selling prices currently.
- The 60-70% typical decline rate for shale production.
- Lack of new drilling to provide incremental new production.
- Lack places to put produced oil, and refined products over the short haul. Given all of the above we see a decline in shale production to between 5-6 mm BOPD. This is a thirty to forty percent decline from current levels.
Darren Woods, CEO of Exxon Mobil (NYSE:XOM), made it plain just how its priorities would stack up in a 30% capex reduction the company announced for 2020.
“The bulk of the capital spending reduction will take place in the Permian Basin in Texas, reducing the pace of drilling and well completions. Deepwater discoveries offshore Guyana will not be affected and the company will delay the investment decision for the Rovuma liquefied natural gas (LNG) project in Mozambique that was expected later this year.”
Rystad, an energy consulting firm, has modeled production at several price scenarios that agree fairly closely with what I’ve projected above.
Over the short haul oil production from shale is going to decline. In most logical scenarios, precipitously from current levels. The question before us is, where will the oil and gas we have demonstrated that is and will be needed in the future going to come from?
Deepwater E&P is an area that’s been under-capitalized the last few years, as all the money was going into shale development. It was just so cheap and easy to keep ploughing money into shale. Buoyed by near zero interest loans and a supportive stand from OPEC to maintain pricing in the $60-80 band, shale development was the obvious solution to maintaining production.
Deepwater by comparison, even though costs had come down since 2014, required huge outlays of capital that were difficult to justify in the uncertain price scenario that the industry seemed unable to shake.
A couple of takeaways from the graphics above.
The Rystad graphic shows that even while it was difficult, some deepwater E&P has been maintained over the last few years. Additionally, it shows that deepwater sanctions are on the rise. With the current distaste for shale, money will be re-allocated to deepwater. Certainly as compared to oil sands – very high cost/environmentally destructive, shelf work – fewer opportunities.
The second graphic shows that conventional discoveries have been on the decline. This is due in part to the original high of developing them as most conventional plays are now in deepwater. What is clear is that we have been reaping the rewards of investments made 10 or more years ago, and soon these reserves are going to play out. Conventional reservoirs decline at an average rate of ~06% a year. When you see the great deepwater investment cycle peaked in 2012, fourth grade arithmetic suggests these plays are entering the final stage of their life-cycle.
There is surely some recognition in the industry of the need to begin the conventional cycle anew as you can see from the third graphic that investments in deepwater are scheduled to rise.
This year will probably be an all-time low for new project sanctions as the rationale basis for taking an FID is pretty sketchy at the present, thanks to the COVID-19 induced demand decline. 2020 is a lost year. When the ground firms up, I expect a flurry of them.
This notion is buttressed by recent press releases from companies like, Shell (RDS.A, RDS.B), where many projects that had been steam-rolling to final sanction, are being delayed. This directly due to the low oil prices we are experiencing.
As has been previously discussed, project redesigns and vendor price concessions have lowered most deepwater GoM project breakevens in the low $30s and even below that in some cases. This is significantly cheaper than most shale development. Chevron with a number of projects under FID review is targeting development costs of $16-20.00/bbl in the GoM. This will lead to a new investment cycle in deepwater stock plays in relatively near term.
As the currently burgeoning supplies of oil begin to fade in the latter part of this year, and this accelerates into the next, it will become painfully evident that the world still runs on oil. Due to lack of development of the deepwater resource in the prior decade, we are likely to see spot shortages, as the world economy recovers from the current downturn.
The price will rise as demands for it increase. We see oil comfortably back in the $40’s by years end, and increasing toward $60 in 2021.
The Saudi gamble of 2020 will have paid off.