Another oil price downturn threatens to deepen the plunging levels of
investment in upstream oil and gas production, which could create a more
acute price spike in the years ahead.
Oil and gas companies have gutted their capex budgets, necessary moves as
drillers went deep into the red following the crash in oil prices. But the
sharp cutback in investment means that huge volumes of oil that would have
otherwise come online in five or ten years now will remain on the sidelines.
The industry will cut spending by $1
trillion through 2020, according to Wood Mackenzie. Those reductions are
creating a "ticking
time bomb" for oil supply. The consultancy projects that the market
will see 5 million barrels of oil equivalent per day (mboe/d) less this year,
compared to expectations before the collapse of oil prices. And next year,
the industry will produce 6 mboe/d less than it otherwise would have had the
spending cuts not been made.
This is creating the conditions for a supply crunch and a price spike. The
reason is simple: demand continues to rise by some 1.2 million barrels per
day each year, but supplies are no longer growing because of the spending
cuts. That is not a problem today as production still slightly exceeds demand
and high levels of crude oil and refined products sit in storage. But by as
early as the end of 2016 the oil market could tip into a supply deficit. And
because the industry has scaled back so intensely on capex, global supplies
could fall short of demand for quite a while. The end result could be a
dramatic price spike.
This scenario has been described before by Wood Mackenzie, which published
an estimate earlier this year that put the total value of cancelled projects
over the past two years at $380 billion, projects that would have yielded 27
billion barrels of oil and gas.
So far, the markets are not pricing in the brewing supply crunch. Oil
prices continue to fall, and speculators have taken the most pessimistic
position in months, selling off long bets and buying up shorts.
Oil analysts and forecasters do not see a rapid rise in prices either. A
Bloomberg survey of 20 analysts revealed a median price forecast of just $57
per barrel in 2017. No doubt that record levels of inventories are on their
minds – even if oil production itself flips into a supply/demand deficit, it
could take years to work through storage levels.
"We're looking at a market that's still in a very slow process of
rebalancing and we don't think that you'll get a sustainable deficit until
the second quarter of 2017," Michael Hsueh, a strategist at Deutsche
Bank AG, told Bloomberg. "Those deficits are necessary to draw down
global inventories, but that will still take until the end of 2018, it
appears."
But the swing from surplus to deficit could be more dramatic than many
think. Now that oil is once again entering a bear market, with WTI and Brent dropping
to $40 per barrel, the industry could be forced to slash spending even
deeper than it already has, leaving even more oil reserves undeveloped. And
in any case, it is possible that high storage levels and the two-year
production surplus is leading to a myopic view of the future – just because
the markets are oversupplied today does not meant that they will in several
years' time.
Wood Mackenzie says that while U.S. shale has been the hardest hit by the
steep fall in investment, the shale industry will be the first to bounce back
because of the short-cycle nature of shale drilling. The price spike will
lead to a resurgence in shale, and Wood Mackenzie is predicting that shale
production doubles from the 2015 high-watermark of 4.5 million barrels per
day to 8.5 mb/d by the mid-2020s.
But that is a long way off for oil executives dealing with deteriorating
balance sheets and rising debt levels.
