Things will get better because they can’t get worse. We’re at or near the bottom. Better times ahead.
But you’d never know based on oil prices or the news. WTI closed August 11 US$43.08 a barrel, a price unseen for more than six years since the dark days of 2009. The commentary is universally bearish. Everyone from analysts to oil company CEOs are saying what you see is what you get for the foreseeable future. Comparisons to the great price collapse of 1986 and the 15-year nuclear winter that followed are again making headlines. It’s not awful; it’s worse.
Numerous challenges exist. Every day there’s yet another reason why oil prices will never increase. Iran. China. Greece. Global inventories. OPEC overproduction. Rising North American rig counts. Carbon taxes. Corporate tax increases. Royalty reviews. No pipelines. The news is so depressing more are saying this downturn is the worst ever, although there is significant evidence to the contrary.
This is not new. What the industry has always done is extrapolate; whatever happened yesterday will continue. If things are good, they always will be. If things are bad they will remain so forever. After 36 years of writing about the always-volatile oilpatch, the only constant is the herd is usually wrong, regardless of the direction it is headed.
First the bad news.
The modern oil industry has never operated without Saudi Arabian or OPEC supply management. The possibility of Iran increasing production if its nuclear inspection agreement is ratified weighs heavily on market sentiment. This is new.
Commodity prices as a group — oil, potash, iron ore, coffee, and copper — are at lows unseen since early this century. This is made worse by a strong U.S. dollar. Hedge funds specializing in commodities are losing money and shrinking as profits become more elusive. This too is new.
Future oil demand is in doubt for three reasons, all new.
1. China, the world’s second largest economy and commodity consumer, has serious financial problems with the long-term impact unknown. The latest blow was devaluating the Yuan.
2. More governments unquestioningly link oil to climate change and are taking steps to ensure consumers use less. We’re told daily the future of mankind depends on using less oil.
3. Near zero interest rates and quantitative easing no longer stimulate economic growth. This affects commodity demand and price.
The replacement cost of tomorrow’s barrels seems unknown. Current production is thought to be impervious to price. Lower prices have always reduced production. That low prices somehow won’t crimp future supply this downturn is also new.
Hide the sharp objects. This is a big batch of misery. Now the positive.
With the exception of oilsands mines, all reservoirs yield less oil tomorrow than today. Typical decline rates for the best conventional reservoirs is 3 per cent to 5 per cent per year and the output of most shale oil wells falls 50 per cent or more in the first year. At 4 per cent globally, this is a 3.8 million bpd decline in the next 12 months at current output of 96 million bpd. Without continued investment production will fall. The latest information is U.S. shale oil production peaked in April and will decline by 360,000 bpd by September. Global oil and supply demand curves simply must and will cross and they will.
Comparisons of the current situation to the mid-1980s remain ludicrous. When oil prices collapsed in 1986 and remained low in real terms for 15 years, world oil supply exceeded demand by about 14 million bpd. This was nearly 25 per cent of world demand of 60 million bpd. The current surplus of supply over demand in Q2 was about 3 million bpd, or 3 per cent. This is shrinking. This is nothing like the situation in the mid-1980s and to suggest otherwise is uniformed and irresponsible.
Rig counts are rising in the U.S. and Canada because they must. Oil companies must drill to survive. Efficiencies always emerge when they become essential. The rise is not meaningful. It is impossible for the reactivation of only 42 of 981 laid down drilling rigs in the U.S. to sustain or increase production.
The next market turn will be dramatic and will be up because it can’t go down. The current mantra is for the first time in recent history and without supply management (see above) somehow crude oil is the only commodity that will trade in a narrow and predictable band when supply and demand achieves equilibrium. The futures curves are wrong.
There is likely no good news in the short term, the next couple of months. Prices may even fall further. Keep the faith.
In the medium term — the next six months — there will be growing stability and confidence if federal and provincial politicians don’t do anything really awful.
But the long term looks good. The herd is wrong again and global oil supply and demand will prove it.
David Yager is the national leader, oilfield services, for accounting firm MNP. He can be reached at david.yager@mnp.ca.
