The end of OPEC ? – and its not Trump, shale, or Tesla

A quick question: what was the global oil demand in 2012?

An interesting article tries to dispel the idea that the Oil Price Spike in 1973 was not a direct reaction to US foreign policy (support for Israel in the 6-days and Yom Kippur wars) but a direct result of US domestic policy, specifically the decoupling from the gold standard. The argument is that the OPEC nations saw their revenues in “real” terms dropping due to the devaluation of the dollar with the gold-standard exit. To recover their losses, OPEC cut back production and raised prices – if this is so it was a bit of a blunt instrument as it clearly overshot. The argument continues that this was not the cause of stagflation as these petro-dollars were recycled back into the economies of the west. The price-manipulation angle is backed by reports of a significant paper trail from OPEC in the years preceding 1973, stating that OPEC would act to recover their position

“member states would automatically adjust crude oil posted prices calculated in dollars if a change in dollar parity emerged from the present monetary crisis.” OPEC Aug ’71

I don’t have any opinion on the merit of this article. However, the idea that OPEC is this huge force in world oil has been a mainstay of media opinion for decades. There have been various chapters in the story; focus on market share, internecine strife between members, focus on price, war on shale, worry about renewables and obsolescence etc.

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Big Oil has done climate change research, and the conclusions are bad

Reading Time: lots, but hopefully worth it. Sound bites are generally not worth reading.

When is a risk not a risk?

Earlier this year, Exxon was in the news for the usual wrong reasons – as an oil company they were accused by various Californian, and other, municipalities of being directly responsible for the threat of flooding that these coastal municipalities were in danger of, due to global fossil-fuel originated climate-change.  

This kind of action by state and regional level administrations actually has an impressive list of victories; several of which appear in Netflix’s Dirty Money series. So, any commentary herein is caveated by the stellar track-record. Notwithstanding this, the action against Exxon is a worrying trait as it expressly compares the oil companies with the tobacco companies of the last decade(s).  This is an important point, as it is an attractive narrative, but also misses the point that our techno-industrial society doesn’t need cigarettes, but does need cheap energy. Whilst this is an interesting avenue to explore I’ll resist the temptation today.

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Bigger fracs disguise lower productivity and why this matters.

The BP Energy outlook published last month, goes into great detail about the changing global energy mix. From some points of view, it is changing rapidly, but objectively, the “energy transition” is going to be gradual, even with the best will in the world.  There is a lot of speculation about when “peak demand” for oil will occur: 2040 seems to be a rough guide, however, it is a plateau and gradual decline. No cliff-edge on the horizon.

Show me the money

What struck me about this detailed analysis is that there is a big omission – at least in the publication – maybe not in the analysis – but who knows? This omission is so fundamental to the world economy, it may just be too complicated, or too scary, to put in.

As I pointed out in a previous post or two, there is a very strong correlation between energy and GDP, and the historical norm has been cheap energy, particularly oil. This is in many ways logical – you look for natural resources in the easiest places (geologically at least), and statistically – throwing darts at a dart board will tend hit the big targets first (apologies to all explorationists out there… not making any disparaging remarks about this noble science – but making a mathematical point).  Evidence that energy is going to get more expensive would point to lower GDP growth – and given the world’s population and aspirations for better standards of living – that could be a disaster in the making, and certainly not something anyone would want to draw attention to in something as mundane as a Global Energy Review.

The BP Energy Outlook doesn’t (as far as I can see) address the question of the cost of all that oil that is going to peak in 2040… and here I start to disagree strongly with many pundits. Discussing oil supply without discussing cost is like dreaming of your next vacation without worrying about your budget… a nice exercise but ultimately likely to end in disappointment and tears.

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Higher oil prices and what happens next

It may be no coincidence that one of my favourite books is called “The Catastrophist” by Ronan Bennet. A catastrophist doesn’t just see the glass half-empty, but empty and broken with shards spelling impending pain and blood… I think this general world-view probably stood me in good stead as a bank-engineer assessing debt deals. What could possibly go wrong? well according to me, a lot, and with hindsight its amazing we did any deals at all.

The first problem with oil prices is that they are never stable – so the “lower forever” banking tag line is about as good as “this time it’s different’, which has never worked as an investment thesis. The second problem is that low oil prices trash our industry. The third problem is that high oil prices trash our industry. And of course the forth problem is that low prices lead to high oil prices (see problem 1, above). This post is (or will be after a brief intermission) about high oil prices. Be careful what you wish for.

Intermission

I wonder whether this is due to my age, or rather my “vintage”, as a child of the 1970s. Britain was bleak and broken, in post-industrial decline, I was not directly affected, but in the extreme opposite of Milan Kundera’s classic “The Uunberable Lighness of Being“, this period was almost designed to traumatize – the unbearable heaviness of existence was brain fodder. I recall school lessons about the impending Ice Age (ironic given today’s consensus view, but actually reasonable when looking at natural cyclicity), the end of jobs (again a certain irony today), an essay project on the “last blade of grass left”, not to mention fun “public information” films (“PIFs”) and ads that ranged from children dying on farms (Apache), on railways “The Finishing Line” in gory bloody detail, and of course the “put you hands over your head and kiss your a** goodbye” in the “Protect and Survive” cold-war nuclear apocalyptic vision where clever use of string, canned food and a good attitude would see you through. For some reason it was always Sheffield that got fried – I never really worked that one out.

As the cold war receded we had been through huge industrial unrest as the fabric of post-war society changed, high inflation and interest rates (remember those?), race riots (“Is Brixton Burning?“), the nuclear Armageddon threat, and just when you thought it couldn’t get much worse, our generation’s “coming-of-age movie” was the 2001-Space Odyssey remake (ie another PIF) with a large obelisk emblazoned with “AIDS” and a blunt message about sex and certain death. Oh to be a Millennial, where the main concern is FOMO, and not enough likes on Instagram.

So what does this have to do with the oil price? Well, it’s just my view, and I thought it best to frame it with some background on my “catastrophist” world view since it gets quite bleak…

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Steel yourself for the next shock

Many moons ago when doing a site visit in one of the ‘Stans, which shall remain nameless, we stopped to look at some road-side oil pipes, which were visibly heavily corroded on their upper quadrants. Baffled by this, I asked the interpreter. Happily, the pipes were not part of the project I was visiting, but an adjacent one. Less happily, the explanation was that the pipes tended to corrode on the underside where small sags caused water pooling and damage…. rotating the pipes 180 degrees extended their useful life in an area where capex was not readily available for replacement. Scary indeed.

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When the wheels fall off

In a previous post I wrote about how I thought geopolitics was being ignored and ought to come back into the oil price equation – it looks like that is starting to happen, the threat by Turkey of shutting of Kurdish exports made a strong point, not ignored by the market. At the same time, surprise, surprise, demand is picking up “more than expected”

The wisdom of the crowds is a nice idea, can result in some surprisingly accurate results. However, we all know about the myriad cognitive biases that afflict us poor humans, and as Ben Horowitz notes in “The Hard Thing about Hard Things”, group think can be very efficient at reaching the wrong conclusion. We have seen this (in my opinion) spectacularly in the past couple of years with the “Lower for Longer” mantra becoming “Lower Forever” as the demise of the ICE is gleefully forecast.  Perhaps that’s a bit harsh, as even those of us in the industry recognize that 100 year old technology is perhaps neither the most efficient form of transport nor the best use of a precious resource like oil.

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Pride before the fall – Lest we should forget.

Maybe there was a certain pride, maybe even smugness, around the O&G industry a few years ago with oil at $100+…  and despite the last 3 years of “downturn”, remnants of this may even remain in some corners.  Smugness, no, but pride, yes.

The reality now though, is that we are proud of an industry that is elsewhere perceived to be akin to tobacco, armaments and banking, vying for last place in the popularity stakes.  At drinks and dinners, say you work in “Energy” not Oil… and feel the different reaction you get.

Currently, the O&G industry gets a good slapping at every opportunity, whether it be the Climate Change agenda (the producer’s fault, not the consumers..), the happy-clappy renewables industry, or even reporting the pain the oil-price collapse has brought to our industry – you can feel the schadenfreude seeping through the mainstream media.

So maybe this is a good moment to reflect on what we do, and what we have done.

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The End of History (again)

So now its agreed. The oil price is “range-bound”. It’s a bit less clear what the range actually is, but variously $40-$50/bbl or $40-$60/bbl.  The “Lower for Longer” scenario playing out exactly as expected. We can all sit back and watch the US shale (“Light Tight Oil” or “LTO”) be turned on when supply is constrained and prices rise and off when supply outpaces demand and prices drop.  And this will continue briefly until oil demand falls off a cliff and we all drive off into the sunset in EVs.  “Lower for Longer” has become “Lower Forever”.

Don’t we all love a nice neat narrative.

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Random thoughts from the news

Venezuela

When I first visited Caracas in 1994, I was struck by how one could see that a once prosperous city had lapsed into decline. Goodness knows what it is like now.  The levels of deprivation are unparalleled in countries of a similar standing. Meanwhile by some miracle Venezuela manages to continue producing some 2.4mmbbls/day of oil. The country is split – as witnessed by last weeks phoney-war; government loyalists queued to test the voting infrastructure – as a dry run for the real elections for the new Constituent Assembly on July 30th, whilst opposition supporters queued to vote in an unofficial referendum. This referendum provided a 98% rejection of the current adminsitration, with reportedly 7.2m votes cast. An unsurprising result given that only opposition supporters voted. Whilst this is a big number it is only about 30% of the eligable voters, so the country remains deeply divided.

Prior to this referendum, the news from Venezuela was largely burried in all the First-World fluff, but it is reported that over 100 people have been killed in protests this year – this is a tragedy in the making for (many) of the people of Venezuela. But at what point is this not geo-political risk for the oil price? Looks to me like the single biggest “wild-card” out there at the moment.

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Bleak Midwinter view of 1H 2016

Is this the winter of our discontent?  

Probably not; times are tough in the O&G sector – but this being the season of good cheer, lets look at how much worse it might get in 1H 2016.

Interest base rates

Later today the Fed is expected to raise interest rates – the first time since mid 2006.  I can barely recall 2006, so nearly a decade has gone by in the era of cheap money.  This isn’t all about to change overnight; the expectation is 25bps, but it is  one variable amongst many that will impact borrowers.  O&G companies are typically big borrowers…  In good times a few basis-points might go unnoticed, in 2016, these will contribute to pain for those already stretched.

RBL – redeterminations and PUDs

The lending banks are going through the 5 stages of Grief; denial, anger, bargaining, depression and acceptance.  

Summer 2015 was denial, oil had had its dead-cat bounce and borrowing-bases were deemed to be fit for purpose.  

Fall 2015 was anger, a fair bit of noise about redeterminations and certain banks downsizing RBL teams, but overall it was noise without any serious downgrades of borrowing bases as banks chose not to crystalze the downswing in oil prices.  

Spring 2016 – looks like bargaining will be a good analogy, as banks and borrowers get down to real negotiations about covenants and redeterminations.   Depression will probably follow rapidly.

To add spice to this mix, there is talk that US regulators are very concerned that the extensive lending to the O&G sector could represent a systemic risk akin to the sub-prime.  Clearly it is different, but the net result may be a restriction on PUD lending – so that RBL goes back to PDP lending (with a haircut).  The alternate will be for banks to increase their Tier 1 capital to offset the ‘risky’ PUD lending.   Forget 2P lending completely.   This is likely to ripple through to European lending, as the US banks won’t be in the bigger syndicates, or worse, the European banks will follow suit.

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