On a temperate mid-January day, I flew South to the Texas Triangle with chief executive Randy Kendrick to visit Sandow Lakes Ranch. I liken his development to the best case of reindustrialization and circular economy envisioned. Many hands were involved and forces at play…
The SXSW IVY Family Office Network conference revealed many trends, and importantly, what investors and entrepreneurs are advancing. Most importantly, the people. Shout out to women for Women’s History month with a few curated inspirations.
The cover story for the D CEO November 2023 energy edition. Some excerpts and backstory are highlighted that preview the feature.
On October 11-12, University of Montana and Montana World Affairs will host a conference covering topics in energy, diplomacy, geopolitics and technology. I’ll present my body of work there.
Re-published from Dialogues, United States Association for Energy Economics These are interesting times for economists charged with predicting oil markets. As the new year begins and the dust somewhat settles from challenging political and geopolitical climates, the question arises: what are the prospects for oil supply in the year ahead? Is the expected tightening of supply really going to manifest? First, OPEC and non-OPEC producers of Russia-plus have pledged to cut production of approximately 1.8 million barrels per day and their ability to comply with the caps is under scrutiny. Second, U.S. exploration and production companies, particularly those with a shale oil focus, are increasing production based on better pricing. Market prices, producer incentives and demand also play their parts on the stage of world oil, and more on that in a follow-up article.
OPEC's dilemma
In late November 2016, OPEC announced it would reduce oil production levels by 1.2 million b/d to a ceiling of 32.5 million, beginning in January. Bloomberg estimates OPEC produced 33.1 million in December, down over 300,000 barrels since November. Still, according to the Energy Information Administration (EIA), OPEC crude oil production is expected to average 33.2 million b/d in 2017. USAEE member and oil market economist Anas Alhajji notes, "Some OPEC members, especially Saudi Arabia, are serious about the cut. When it comes to production cuts, Saudi Arabia matters the most." He says OPEC would need to shave off 2 million b/d from December's output to meet its target, but that a cut of 1.2 million b/d is sufficient to increase prices. As for the forces driving prices in 2017, Alhajji cautions that production increases in both Libya and Nigeria, countries that abstained from any cuts, could have an impact as well.
In the past, OPEC production quotas have been predictably unpredictable. It is possible that the latest round will fall prey to an "animal spirits" syndrome in hindsight — "a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities." The urge to action is not spontaneous, but the intentions are good and the real options challenging. According to James Smith, USAEE's immediate past president and financial economist at Southern Methodist University, he expects about 75% of the cuts to occur in the first couple of months, but then production begins expanding again, resulting in a limited and temporary impact on prices. "The agreement among the parties is not “incentive compatible” from the perspective of economics," Smith states.
Incompatible incentives
In the grand scheme of production cuts, this incompatibility, specifically smaller producers ex-Saudi Arabia and Russia, stems from these producers' output comprising a small fraction of world output. "Their production levels have no perceptible impact on the market price," Smith adds. "However, their production levels have a large impact on their own revenues, which rise due to extra sales gained from departing from the agreement." With no enforcement mechanism, a repeat of violations by OPEC countries is expected to happen again, as in the past.
Then there is the case of the many thousands of U.S. oil and gas producers, beholden to their own company-level economic incentives. As prices for West Texas Intermediate crude oil approached and passed the $50 per barrel mark, numerous U.S. producers began increasing production. In the Energy Information Administration's recent forecast, U.S. crude oil production is forecast to average 8.9 million b/d in 2016 and 8.8 million b/d in 2017. Incidentally, about 500,000 barrels per day of crude oil were exported through October 2016, with more than half arriving at shores other than Canada, the chief U.S. export market. According to Smith, "each shale producer is a price taker. Every barrel of shale oil that can be developed economically will be developed and put on the market," he relays.
In the Permian Basin, for example, a falling rig count began to increase in June of 2016. In the October to November period, rigs increased by 16 to 223 in the region that has seen less production declines (even gains) relative to others.[1] One executive of a top Texas-based independent oil and gas firm expects 100 rigs to be added over a year from a late September statement. With economic incentives similar to the smaller OPEC countries, "Their collective production may drive the price down—to their collective misfortune," Smith surmises. U.S. shale production increases are not expected to reduce prices but limit an increase, according to Alhajji.
The price is right?
Suffice to say, supply could conceivably be kept in check for 2017, mirroring demand growth. "Shale may dampen longer term price movements, but not short-term volatility," notes Smith. Demand for oil in general and demand growth in particular are difficult to predict in this post-financial crisis world, one in which monetary policy has been playing an outsized role in investment decisions. The jury may still be out regarding the new normal.
Jennifer Warren is a writer and communications specialist focusing on energy, resources and thought leadership work for companies and institutions. Her work has appeared in numerous academic, policy and business publications.
[1] See December 16, 2016 report at the Dallas Federal Reserve Bank
The Dallas Committee on Foreign Relations recently posted the inaugural publication of its "Global Themes Forum," an occasional series of articles, essays and thought pieces about topical global affairs issues. The first installment is a thought piece on global oil markets titled, "U.S. Energy Supply Alters Benchmarks and Trade Scenarios." See the item listed January 27,2015. And if the big picture isn't of concern, a dive into global oil markets after the Saudi succession, or how consolidation in the U.S. energy industry is beginning, may be of interest.
1) "Post-Saudi Succession, Oil Markets Seeking An Elusive Equilibrium" here.
2) The Energy Transfer merger between "family" members: "Energy Transfer Merger Creates Second Largest MLP, Scale Economies" here.
The timeframe of November through the first part of December saw levels of volatility in oil prices unseen for years. This article details some of the numbers supporting the shapeshifting market. But, in time, the fundamental drivers of supply, demand and geopolitics will clear up the tattered picture, as it always does. The OPEC decision to leave quotas intact created a tsunami effect for industry players. However, a slight bit of clarity is emerging as one large oilfield services firm notes some initial observations in production and investment activity around the world.
As of October 23rd, a floor may have firmed up beneath oil prices in the low $80 range for WTI. Major oil field services firm Halliburton does not see signs of its customers altering production plans at present. Large independent producer Occidental Petroleum notes in its earnings call for the third quarter that they are not making any deviations from earlier plans in the Permian Basin. (See a more in-depth article about oil market fundamentals and market players, "Global Oil Markets: There and Back Again.") From last week, when the bottom was nowhere in sight, the oil market appears to be finding its equilibrium, rising up from the lower $80s for both WTI and Brent crude prices. This series of articles provides numerous charts of fundamentals, including what margins a few key Permian Basin players rely on to produce profitably:
The expert insights in the "Global Oil Markets..." article are derived from the commenter very recently visiting Saudi Arabia.
