Oil - State of Flux

On a daily basis over the past 24 months, we have heard and read about the significant drop in trading prices of crude oil. The two main trading contracts for crude oil, Brent North Sea and West Texas Intermediate (WTI) have seen their prices plummet to lows of roughly USD 30 per barrel in the aforementioned period. Today, we have observed a recovery and stabilisation of prices to a range of USD 40 to USD 50 (See Figure 1 & 2).

Figure 1 - Trading price of Brent 2014–2016. Source: Bloomberg

Figure 1 - Trading price of Brent 2014–2016. Source: Bloomberg

Figure 2 - Trading price of WTI 2014–2016. Source: Bloomberg

Figure 2 - Trading price of WTI 2014–2016. Source: Bloomberg

Low demand and overproduction

It is acknowledged that this period of “low” oil price can be explained by slowed demand coupled with oversupply/overproduction (See Figure 3 for summary). Global oil demand growth is slowing at a faster pace than initially predicted. Factors that have caused lower demand for crude oil are:

  • Increasing adoption of renewable energy sources
  • Enhanced performance of internal combustion engines
  • Mainstream availability of electric vehicles/transport

Production levels of crude oil have hit record levels since 2008. Fueled by Wall Street credit pre-2008, new Exploration & Production (E&P) companies were created and began buying smaller offshore blocks that were neglected by the supermajors (Exxon Mobil, Royal Dutch Shell, BP, Chevron, ConocoPhillips,and Total). This has meant many more new developments reaching first oil. Meanwhile, the United States has pioneered the controversial ”fracking” technique, which has led to the number of wells in the USA increasing from 23,000 to 300,000 in 2015. This has in turn led to 4.3 million barrels of oil per day being added to bustling output channels. Iran — a major oil producing country — has had its trading sanctions lifted recently, allowing them to freely trade their oil after several years of restraint. Consequently, Saudi Arabia increased their production levels to fill the void left by Iran (when Iran had sanctions imposed). All of this has led to a huge surplus of oil, poignantly illustrated by oil tanker traffic jams at ports in Iraq and China.

Figure 3 - Oil Market Imbalance 2014-2016

Figure 3 - Oil Market Imbalance 2014-2016

Impact

The impact of these sustained “low” oil prices has led to many billions of dollars worth of E&P projects being put on hold or shelved permanently. When the price of oil was around USD 100 per barrel, companies spent billions of dollars investing in new developments; thus increasing production levels. This outlay of resource meant that the viability of their projects were dependent on high oil prices. When the price of oil crashed, it resulted in several hundreds of thousands of jobs lost and a gloomy outlook for the Upstream Oil & Gas industry. Spending by Big Oil companies was curtailed and this curtailment is expected to be maintained for several years. In the long-term, energy companies may struggle to meet E&P targets and technological challenges well into the future.

The Future

Today, the world consumes approximately twice as much energy as it did in 1971 with crude oil and natural gas being the mainstays of our energy supply, followed by coal, biofuels, geothermal, solar, wind, and heat. According to the International Energy Agency’s forecasts, our current energy consumption will increase by roughly 30% by 2040, mainly due to a population increase. To meet these future energy consumption demands, we need to maintain and increase E&P activities. If investment levels are not adequate, demand could eventually exceed supply and therefore spark a return to lofty oil prices.

As a society, we have been dependent on oil since the early 20th century, and we have experienced many cycles of boom and bust regarding oil prices. Many oil producers have gone bankrupt in the past 12 months due to pressure of repayment of loans from banks. This could affect supply. Moreover, the pending decision of the Organization of the Petroleum Exporting Countries (OPEC) to potentially reduce oil production levels and cause oil trading prices to rise significantly.

Practically all of the supermajors are investing in other energies, complementing their traditional oil production. In this way, they could meet challenges and requirements well into the future, while also adding value to their businesses. Examples of this include Shell investing its future in LNG (See Figure 4) and Total paying more attention to Renewable energies.

Figure 4— Shell Prelude — Floating liquefied natural gas vessel

Figure 4 — Shell Prelude — Floating liquefied natural gas vessel

It can be observed that energy companies are beginning to adopt and implement Digital Technologies across all of their activities in order to effectively meet, monitor and manage future energy demands. Technologies such as Software-as-a-Service (SaaS), Big Data and analytics capabilities are seen as lynchpins for enhancing oil production, maintaining asset integrity management, and diversifying into other energy sources. Perhaps the future is tending to become less dependant on oil.

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