THERE are mixed messages coming out of the corridors of power at the World Economic Forum in Davos, Switzerland, with regard to crude oil prices, the current oil market and the major rival players — Saudi Arabia and its Gulf supporters within the Organization of the Petroleum Exporting Countries (Opec) oil cartel and American shale oil producers.
Take your pick of the likely winner. For me, over the long term — like it always has been in the past — the signs point to Saudi Arabia. The Saudis have been in this position before. They are not new to a low oil price environment and they know what to do.
The oversupply situation is still not that excessive, averaging nearly one million barrels per day (bpd) in the fourth quarter of last year. During this period, the International Energy Agency (IEA) — the Paris-based energy watchdog of the developed world — estimated demand at 93.4 million bpd against supply of 94.3 million bpd.
IEA is looking at demand of 92.5 million bpd in the first half before it climbs to 94.4 million bpd by the end of the year. But the current oversupply situation, if not controlled — and it looks like none of the big producers are willing to do it — could push the market into a glut environment.
With proven reserves of 266 billion barrels and a production cost of US$10 a barrel at its major giant fields, the Saudis can dictate the game they want to play in the international market. They can reduce production and ease oversupply or maintain production and let prices drop slowly. Or, like they did in the mid-1980s — when no one wanted to give in, including some Opec members themselves — they could open the floodgates and let prices tumble.
The Saudis in 1985 decided that enough was enough and stopped acting as the swing producer to stabilise prices. Instead, they let the price drop to below US$10 in 1986. For oil, just like any other commodity, the long-term cure for low prices is simply — low prices.
So, will Saudi Arabia this time around maintain its current output of about 9.5 million bpd and let the American shale players — which propelled the US into becoming the world’s largest producer last year — produce more and let prices dip further?
At Davos, Bob Dudley, CEO of oil super major BP, gave this view to the BBC: oil prices can remain low for up to three years. Reason: historically, world oil prices have fluctuated in cycles and sometimes have remained low for a number of years. This could be the time, when large producers that can influence the market have not indicated their willingness to cut production despite the supply of crude at record highs.
Oil prices averaged US$110 per barrel from 2010 until mid-2014, providing stability to the market, but have collapsed to below US$50 in the last six months. If prices remain low, expect the major players to reduce their investments in development and production, especially in high-cost areas like the North Sea and deep water acreages. New exploration will basically stall.
Job losses have already been reported, even among the US oil shale producers. What would happen in the next few years if prices remain low and dip further is that supply will be disrupted, pushing prices up, perhaps very quickly.
CEO of Italian oil group ENI Claudio Descalzi says the oil industry, led by the majors, will cut capital expenditure 10% to 13% this year because of slumping prices. If this persists, it could create long-term shortages and a sharp rise in prices in four to five years.
The next spike, says Descalzi, could push oil to the US$200 a barrel level. France oil major Total CEO Patrick Pouyanne, on the sidelines at Davos, echoes Descalzi’s warning.
“There is a natural decline of 5% (production) a year from existing fields around the world. That means by 2030, more than half of the existing global production will disappear. There is an enormous amount of money that needs to be invested to get another 50 million bpd of new production,” says Pouyanne.
And that money will not come in a low-price environment, which will discourage the oil majors from exploring more difficult terrain and deeper seas. What the world needs is stability in price, at a price range that will encourage continuing investment and is commensurate with producers’ expectations and at the same time, is deemed reasonable for consumers. The question is what is the price range, and equilibrium level?
Some industry experts say the new trading range could be between US$20 and US$50 a barrel but the Saudis, Opec and other major producers are unlikely to let prices fall towards the lower end of this range in the long term.
For the time being, Opec is holding firm in not cutting production until the shale producers realise that they too have to shoulder their fair share of responsibility in helping to maintain a price range that will encourage continuing investments.
Opec secretary-general Abdullah El-Badri argues that Opec’s production has remained steady at about 30 million bpd for a decade, while US shale producers have added seven million bpd to the market. “Why should low-cost producers cut their output to make way for high-cost producers? It does not make any sense.”
In Davos, he said he was confident that “the price will not go to US$20 or US$25. I think the price will stay at where we are now. We have seen this before — prices coming down very fast and going up very slow. But prices will rebound.
“Everyone tells us to cut. But I want to ask you, do we produce at higher cost or lower cost? Let’s produce the lower-cost oil first and then the higher cost. [If this is followed] we will go back to normal soon.”
For the Saudis, the linchpin of Opec, the death of King Abdullah is unlikely to affect its game plan. With huge reserves and a much lower cost of production than the American shale players, it can afford to play the waiting game. Some industry obser-
vers have predicted that if crude oil
prices dip below US$40 per barrel, 20% to 30% of the US shale producers will have to shut down as production becomes too expensive.
Some liken Opec and the Saudis to a central bank for the oil market, with its role being to stabilise the market, but unless the shale producers, notably the Americans, cut back on production, this central banker is unlikely to buckle.
And if the American shale producers insist on pumping more oil to an oversupplied market and let prices dip further, the fear is that the Saudis will play the one card they know in such an environment, which is to flood the market. That is a scene no oil producer would want to imagine.
Azam Aris is senior managing editor at The Edge
This article first appeared in Forum, The Edge Malaysia Weekly, on January 26 - February 1, 2015.