2010 > 2019: Decade of Disruption - Oil and gas — a tale of two extremes

This article first appeared in The Edge Malaysia Weekly, on December 30, 2019 - January 05, 2020.
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THE 2010s have certainly been volatile for the oil and gas sector. The first half presented the best years in the business, followed by one of the largest oil price shocks in modern history, which humbled the industry into accepting the “lower for longer” prices seen today.

Two narratives pushed crude oil prices to two extremes: few predicted that the US’ venture into shale oil would propel the country back onto the top producers list, and the response of market leader Saudi Arabia to this development that shook the industry.


2009-2014: Shale boom on prolonged high prices

The story of today’s “new norm” began precisely at the start of 2009.

The industry had just bottomed out from the 2008/09 global financial crisis, which saw oil prices crash from US$140/bbl to US$45/bbl in just six months.

As the Organization of the Petroleum Exporting Countries (Opec) curbed oil production to stabilise the market, prices staged a swift V-shaped rebound to US$100/bbl.

On the back of geopolitical tensions in oil-producing countries in the Middle East and Africa, the rebound extended into a three-year party where prices hovered at a lofty US$100/bbl between 2011 and 2014.

The industry was in a state of euphoria, seeing the emergence of high-flying oil companies offering high-paying jobs everywhere. Everybody wanted a piece of the action. In Malaysia, the number of oil and gas service and equipment firms mushroomed.

More importantly, the prolonged high prices allowed players to seriously look at unconventional resources that were otherwise not commercially viable due to the higher cost per barrel involved. These comprised ultra-deepwater exploration, marginal oilfields and other forms of unconventional oil, such as tight oil, oil sands and the most widely explored of all in the US — shale oil.

The promise of high returns prompted a slew of investments and R&D, especially in the US, which has estimated shale oil resources of 80 billion barrels.

At this point, the shale business was dominated by independent companies. Compared with the oil majors, the independents were more willing to experiment with the dirtier shale drilling methods in spite of environmental concerns that were raised at the time.

According to the US Energy Information Administration (EIA), US production rose 76% from 5.4 million bpd in early 2010 to 9.5 million bpd at end-2014, with growth coming almost entirely from unconventional oil.

During this period, the US oil rig count increased more than threefold, from around 450 rigs in 2010 to just under 1,500 in 2014, in which year the gain in US oil production alone exceeded that of global demand.

In between, global demand softened as China’s economic growth started to lose steam. But US independent shale players showed no sign of cutting back. Coupled with an end to US sanctions against Iran at the time, the resulting oversupply caused prices to retreat in mid-2014.

The market then turned to Opec leader Saudi Arabia to facilitate a production cut to support prices, like it did in 2009. When Opec decided in November 2014 to do nothing, crude oil prices plunged.


2014-2016: A battle for market share

Historically, Saudi Arabia would respond to a mismatch in the oil market by tweaking its production volume to stabilise prices, considering its huge dependence on oil revenue. Reports in 2019 estimated that a balanced budget for Saudi Arabia would require oil at US$80/bbl to US$85/bbl.

Awed by the surprising US shale boom, pundits in 2014 saw Saudi Arabia losing its grip on the oil market. Furthermore, certain shale drillers had become more efficient — the average US shale break-even price was US$65/bbl in 2014 and heading even lower.

But Saudi Arabia, sacrificing its own foreign reserves, and Opec nudged prices into free fall from 2014 to 2016 to protect their market share from the up-and-coming. The term “lower for longer” gained traction during this period as the industry lacked direction.

Compared with shale drillers, Saudi Arabia’s national oil company, Saudi Aramco, touted an average break-even crude oil price of under US$10/bbl. Meanwhile, onshore Middle Eastern production costs averaged US$27/bbl.

The entire industry suffered as crude oil prices fell to a 13-year low of US$27/bbl in January 2016.

Some say Saudi Arabia staged the price slump to hurt Iran’s finances — the two nations were competing to assert dominance in the Middle East amid an ongoing proxy war.

In the face of uncertainty, oil majors around the world halted exploration, cut spending and revisited their business model to be more cost-effective in order to protect margins.

But more importantly, the slump rendered the majority of shale drillers unprofitable. Many companies went bust while others cut production, resulting in prices hovering in the US$40/bbl to US$50/bbl range.

For Malaysia’s own Petroliam Nasional Bhd (Petronas), the low oil price environment prompted it to accelerate its diversification downstream to establish a natural hedge — downstream products theoretically have higher margins when crude oil prices are low, and vice versa.

It also bet big on gas, venturing into North American shale gas in Canada to bump up its reserves of the “cleanest fossil fuel”, which some opined would be the transition fuel of choice for power generation as civilisation moved towards a low-carbon future.

Other oil majors like Shell PLC also took the gas route and companies were competing to showcase their expertise in the business.

Petronas led the way by becoming the first company in the world to operate a floating liquefied natural gas (FLNG) asset — FLNG Satu — which began production in 2017. FLNG Dua is slated to start operations in 2020.

At home, Petronas developed the US$27 billion downstream hub, Pengerang Integrated Complex, which is the national oil company’s single biggest project to date.


Lower for longer

Crude oil prices breached the US$50 barrier in November 2016 after Opec, together with other aligned non-Opec nations, cut production from January 2017 and extended the cut until June 2018.

Combined with the news that the US might reimpose sanctions on Iran, prices touched a four-year high of US$86/bbl in early October that year.

At that point, Saudi Arabia and Russia planned to pump more oil into the market to fill the vacuum left by Iran’s absence.

Their plan backfired when the US granted waivers to major Iranian customers. Shale operators were back in action again as prices recovered. In between, analysts pointed to lower-than-forecast oil consumption.

Oil went into a bear market as prices fell 41% to US$50/bbl in just two months by end-2018, effectively cancelling out the gains that took one year to build up.

In 2019, Brent crude averaged US$64/bbl, down from US$71/bbl the year before. Shale oil helped the US overtake Saudi Arabia and Russia as the world’s top oil exporter for the first time in ages, exporting nine million bpd in June.

In the background, Opec revived its pledge to curb production. Saudi Arabia played along, as this time it had another agenda to take care of: the long-delayed listing of Saudi Aramco.

Uncertainty in the oil market would have hurt the intended valuation of US$2 trillion and in turn affected Saudi Arabia’s monetisation of the “world’s most profitable company” to fund its economic diversification away from oil by 2030.


The next decade — one of price stability

For 2020, the US EIA has forecast Brent spot prices averaging lower year on year at US$61/bbl. At home, Petronas has set its Brent crude oil price benchmark for its internal budget at the “high US$50s” per barrel as opposed to US$66/bbl in 2019.

The US is still expected to be the main contributor to non-Opec supply growth next year, followed by ongoing ventures in other unconventional oil reserves, which would put a lid on prices on the back of slower demand growth.

These estimates come on the back of electrification, beginning with motor vehicles, which accounted for 50% of global oil demand in 2017.

The pace of electric vehicle and battery technology development — global carmakers have pledged to invest more than US$300 billion in EVs, according to Reuters data — is worth keeping an eye on.

Meanwhile, the shale sector will see a pickup in industry consolidation as oil majors with deep pockets and high technological expertise sweep in to buy over financially stressed independent companies.

The oil majors are just as disciplined as their counterparts in Opec as opposed to independent players when it comes to ramping up production. As existing players would prefer oil prices to be stable rather than high but volatile, one can expect prices in the next decade to be rangebound with a floor that is acceptable to everyone.


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