Supply and demand

When the oil price drops, people want to know how long the decline will last and when it will go back to “normal.” Audrey Leon reports on how market watchers and researchers tried to make sense of the downturn at this year’s SPE Offshore Europe conference.

Deidre Michie. Photo from Reed Exhibition.

Comparing the current downturn to oil price drops of decades past, one thing seems certain from the data: when supply outweighs demand, the oil price plummets, leading not only to a reduction in production but decline in investment, which in the long-term leads to future production shortages, and the cycle will continue, said Manouchehr Takin, a London-based international oil and energy consultant who spoke at this year’s SPE Offshore Europe.

For the industry, it’s obviously not great news. Takin noted that there are serious budgetary constraints and economic/social crises for all exporting countries – OPEC and Non-OPEC. The fall in price has also meant a fall in investment and massive staff reductions in world oil industry, not least in the North Sea.

In the UK oil and gas sector alone 5500 jobs have been cut. And with those cuts comes the bleak news that in 2014, the UK Continental Shelf (UKCS) spent more on operations than it earned from production, despite the fact that around the globe oil was trading near US$100/bbl. “The situation has been exacerbated due to the sharp fall in commodity prices,” said Oil & Gas UK chief executive Deirde Michie. “We are all too well-aware that this is unsustainable and that investors are unwilling to commit to fresh activity. That is a deeply worrying place to be in.”

Adam Davey, economics and market intelligence manager, Oil & Gas UK, noted that volatility in oil prices is nothing new, but declared that the difference between the oil price drop in 2010 and now is that no one expects a quick recovery this time. “We will be in the $40s per barrel for the foreseeable future and we need to readjust the business to make sure it copes,” he said.

Clair Ridge installation. Photo from BP.

But ultimately, Takin said that lack of investment, means that when demand returns, there could be supply shortage. “If investments are falling by 30-50%,” Takin said, “less investment means there might not be enough oil.” However, for the world economy, the news is less bleak. The low price could lead to global growth being boosted by 0.3-0.8%.

Takin, an Iranian native who worked for the OPEC Secretariat in Vienna for nine years, presented many factors that come into play with oil price fluctuations. For example, not only is the price affected by supply and demand tensions, but also financial players who can accentuate the price.

“For two to three decades the price of oil was $20/bbl,” Takin said. “You forget about those times when it’s been $100, but we had it for decades.”

One day the market woke up. In 2008, oil reached a high of $147/bbl when only five years previous in 2003, it was $25/bbl. How did this happen? Well, the simple answer was that the market conditions were ripe for a price hike.

Looking at the late 1990s downturn, OPEC had made a decision to ramp up production in 1997, despite a recession in the Middle East. That decision caused the price of oil to fall under $10/bbl in 1998. Takin noted that it took two years for the price to go back up. But because of the lowered oil price, oil companies cut investments, due to a lack of confidence in the market.

“So, there was five years of underinvestment by companies,” Takin said. “Based on the oil price collapse, companies didn’t have confidence prices would go up. When they were doing project evaluations, their cut off was $14-15/bbl up until 2002-2003.”

Adam Davey. Photos from Reed Exhibition.

Takin said that when investment began 2004 onwards, and the global economy began to recover, there wasn’t enough oil supply. “Demand was increasing, but supply could not catch up, the imbalance kept pushing up the price of oil.”

The shortage of supply gave way to numerous stories in the media discussing peak oil and the end of oil as we know it. Takin said that this perception of peak oil and running out of oil accentuated the climb to $147 by July 2008. However, just as quickly as the price rose, it soon fell, plummeting to $30/bbl by yearend 2008.

By 2009, the US shale revolution had started, due to new technology and increased investment, reversing a trend in declining US crude production, where peak production of 10,000 b/d was achieved in the 1970s, and quickly fell through the next three decades.

But, by 2014, conditions were once again ripe for the cyclical market downturn. OPEC met in Vienna and decided not to reduce supply and thereby reduce their market share, Takin said.

Figures from the OPEC Monthly Oil Market Report from February 2015, show that in 2013-2014 the world’s oil demand sat at 1 MMb/d, while the world’s oil supply (excluding OPEC) sat at 2.2 MMb/d, Takin said. The need for OPEC crude sat at -1.2 MMb/d. Takin said that the oversupply would be worse had production from Iran and Libya been a factor.

For 2016, Takin notes that non-OPEC production will increase by 0.3 MMb/d, but excess supply will still persist, which means a continued downward pressure on price. In order to balance market, excess oil supply has to reduce 2-3 MMb/d, he said.

But, with the Iranian nuclear deal hanging overhead, where does Iranian oil fit into the scheme of things? Takin said we won’t suddenly see 1 MMbbl flood the market. “I think it will be gradual, not quickly,” he said. “But, by next summer, probably.” And already, just due to the news of Iranian oil, Takin says we have seen downward pressure on the market.

Industry challenges

John Pearson

The overall theme of this year’s Offshore Europe conference was boosting efficiency and remaining positive in the face of challenging times. Michie told the crowd at the Oil & Gas 2015 Economic Report breakfast that the market is adapting. “Companies like Halliburton and Baker Hughes, Shell and BG Group, Schlumberger and Cameron are merging, and infrastructure needed for the future is being acquired by firms focused on providing that service,” she said. “A new business model is emerging on the UK Continental Shelf, one that can tackle the challenges a mature basin like ours.”

However, Oil & Gas UK’s data proved Takin’s point that downturns lead to a loss of confidence and investment, especially on the UKCS.

“There’s very little new fresh investment,” said Adam Davey, economics and market intelligence manager, Oil & Gas UK. “Without more investment, investment could go down to £4 billion per annum by 2017. The average is around £8 billion per annum.”

For the UK sector, Oil & Gas UK’s data showed a dramatic rise in investment from £6 billion in 2010 to its peak of £14.8 billion in 2014. Davey says this investment is expected to fall at a rate of £3-4 billion over the next few years. He attributed the rise in spend due to recent projects such as Clair Ridge, Schiehallion/Quad 204, Laggan-Tormore, Mariner, Golden Eagle.

“Many of those projects are not yet complete,” he said. “The capital investment, some sanctioned 2-3 years ago, is still being spent in 2015, 2016 and 2017.”

Another issue in need of fixing is rising costs. Davey said Oil & Gas UK’s data showed that while operating costs have been fairly controlled, there was a dramatic spike in 2010 and since then costs have grown 10% per annum.

“The increase is stark, and while some of this is good spend, the increase is so stark that some must be inefficiency,” he said. “It’s not all bad. Some of this investment has gone to improve production. Asset reliability is increasing. There’s a tradeoff between spending now and enjoying benefits later.

“However, no matter how you look at it, such increases must be exceptional, we cannot continue to see cost grow at 10% per annum on the UKCS,” he said.

John Pearson, Group President, Northern Europe and CIS, Amec Foster Wheeler agreed. Pearson, who was also presenting at the breakfast event said: “We can’t change the oil price, but we can do something about cost. In terms of unit capital expenses, we have seen 20% CAGR over the decade. No other industry can sustain that.”