Oil Faces Permanent Decline After One Last Price Bounce
Amid conflicting assessments, a slightly longer-term look at oil’s future suggests that rather than a return to boom times, the sector faces a “dead cat bounce”—a one-time spike in price and activity, followed by permanent decline and ballooning liabilities.
The sector has seemed to have at least nine lives in the past, always surging back from temporary downturns in production and profit. Still, anyone following recent headlines on oil prices could be forgiven a case of whiplash. One recent Google search of the term “price of oil” turned up a story predicting a price crash to US$10 per barrel, next to another forecasting a $70 price by year-end.
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At one point over several days last month, Bloomberg News—a generally pro-clean-energy and climate-science-respectful news generator, republished in pro-fossil outlets like JWN Energy and Rigzone—offered a brisk barrage of headlines and updates that spoke to a conflicted industry.
In late September, the news service enthused over the “60 billion to 70 billion barrels of yet-to-be pumped crude oil” that London-based market analysts IHS Markit Ltd. had just estimated could be recovered from the shale in Texas’ and New Mexico’s Permian Basin. The giant pool was “enough to supply every refinery in the U.S. for 12 years and have a market value of about $3.3 trillion at current prices for West Texas Intermediate oil, the domestic benchmark,” Bloomberg reported. [Although previous sky-high estimates of the Permian’s resource have been contested.]
But on the same day that it covered the apparently bullish news for “the hottest oil patch anywhere on Earth,” another Bloomberg story was reporting that “jitters mount” in the very same oilpatch, as frenetic activity seemed to invite a familiar cycle that always ends in a bust.
And a day later, the same news wire drew attention to where that bust has already arrived, the smaller Eagle Ford shale patch some 400 miles to the east, where drilling has plummeted with the rush to the Permian. “Lives are turned upside down. Plans are crushed. Savings are drained.”
Then on September 27, Bloomberg ran a story that, as republished on JWN, declared a “sustained bull-market rally” for oil contracts being traded in New York, “as demand for American crude pushed exports to a record.”
Oil trader Matt Sellee, whose employer, Tortoise Capital Advisors LLC, manages $16 billion in oil-related assets, described oil demand as healthy. “The punchline is that OPEC compliance has been pretty strong,” he said, suggesting that prices will remain firm.
Buried in the same story, however, were less optimistic indications for oil markets, with projected crude oil prices for November declining and inventories of key commodities like crude oil and refined gasoline—which tend to drive down prices when storage volumes increase—on the rise.
Clearer Price Risk for Canada
The same run of Bloomberg reporting produced an even clearer picture of the long- and short-term risks facing the Canadian tar sands/oil sands.
Both the Permian’s shale drillers and Canada’s tar sands/oil sands producers “have posted some healthy profits so far this year,” Bloomberg observed September 28. “But it’ll take oil consistently above $50 a barrel for their investments to pay off in the long run,” according to a Moody’s Investor Services survey of 37 exploration and production companies in Canada and the United States.
In that environment, shale wells that can be drilled in months are better positioned to take advantage of short price booms than bitumen extractors that cost billions to build, and must operate at a profit for decades to return their investment.
With scepticism reigning for the prospects of a long-term price above the $50 benchmark, Bloomberg had earlier reported, money has dried up for new exploration in Canada. “The dearth of fresh capital has trimmed the ranks of [smaller exploration companies] dramatically,” it reported, “bringing the search for oil and gas in Canada nearly to a standstill.”
In dire terms, it speculated that the sub-sector’s “extinction could have far-reaching effects, making it harder for the industry to ramp up production when prices rebound by depriving large producers of the buyout targets they typically rely on to replenish reserves.”
At about the same time, JWN reported that barely one-third of drilling rigs in western Canada were in use.
Bulls Turn Bearish
As recently as August, JWN was observing a “remarkable consensus” among oil market watchers that “it’s just a matter of time” before undiminished and even growing market demand for oil collides with current under-investment in exploration and new production, setting up a shortage of oil supply.
“Despite the relentless hype about oil demand destruction caused by electric vehicles, renewables, and petroleum-driven climate change, there is no end in sight for oil being the world’s number one transportation fuel,” that report cheered. “Prices are going to rise.”
By last week, investor blog Seeking Alpha was telling a different story, at least for Canada’s heavy oil patch. It warned that scheduled production increases and limited pipeline volumes to southern refiners would deepen the discount buyers charge against Western Canadian Select diluted bitumen compared to West Texas Intermediate crude oil, to as much as $15 a barrel. With oil at $50, that would mean a take-home price for Canadian supplies as low as $35 a barrel, as soon as November.
“Oil and gas executives’ confidence in a quick industry recovery” seemed to have evaporated, pro-fossil JWN Energy reported meanwhile, citing Deloitte’s 2017 Oil and Gas Industry Executive Survey, “with lower expectations of a rapid price recovery.”
“The new reality seems to have set in,” said Deloitte’s Andrew Slaughter. “Waiting for a significant price recovery may be a long haul.”
At the end of September, CBC News concluded a retrospective on the 50th anniversary of Canada’s first tar sands/oil sands extraction plant near Fort McMurray in its centennial year, with starkly different prognoses for the industry’s future. “We will earn the right to be here for the next 100 or 200 years,” declared Steve Williams, the chief executive of Great Canadian’s successor company, Suncor.
“I wouldn’t invest in that,” countered the Pembina Institute’s Simon Dyer. He accused the Alberta industry of living “in a bit of a bubble,” failing to notice that “you have countries like France and the UK announcing they’ll be banning the combustion engine by 2040. You’ve got China and California musing about doing the same thing.”
The Last Oil Spike
So which is it? “Lower for longer” or “lower forever” for oil prices, as some analysts term it? Or higher prices ahead?
The answer appears to be both—depending on time frame. In a cogent analysis published only 10 days after JWN’s prediction of rising prices, Europe’s EnergyPost explained the contradiction that other outlets would soon be reporting.
In brief: JWN’s analysis is right, with a delay. Yes, cuts in oil exploration do imply supply shortages later, and most analysts don’t think that by the time they arrive, electrified transportation will have reached the scale necessary for demand to fall in step. The result: higher prices.
But look a little farther down the road, and the expected price advantages and technical improvements in both renewable energy supply and the electrification of surface and even air transportation begin to tell—even without aggressive global measures to wring carbon emissions out of the economy.
The oil business seems to have absorbed the first half of that forecast: the coming bounce in crude prices. Nearly two-thirds of the oil executives in the Deloitte survey expected West Texas Intermediate to hover around $40 to $50 per barrel (less that discount for Canadian heavy crude) for the rest of this year, rising slowly to $50–$60 next year, and reaching as high as $70 per barrel—a level at which even high-cost Canadian producers are confidently profitable—by 2020.
Those price levels may last the better part of a decade, but they will end when electric car penetration—and policies eliminating internal combustion vehicles—begin to kick in. And that will happen by 2030. It’s only then, EnergyPost writes “during the 2030s and 2040s, that the oil industry should expect to experience the really painful impacts.”
Which means fossil producers can’t expect the longer-term future some of them are touting, but the industry as a whole must undergo a more aggressive managed decline to hit the mid-century decarbonization targets that will hold off the worst effects of climate change.
Three Killer Threats
Working against the fossil industry’s longer-term future are three different threats, Mark Lewis, managing director of Barclays Capital Investment Research, told the New York Times on the sidelines of the 38th annual Oil & Money Conference, co-hosted by the Times and Energy Intelligence.
“Policy risk stems from increasing efforts to address climate change and resource dependency,” Lewis said. “The rapidly improving economics and competitiveness of renewable energy and electric vehicles” pose technology risk. And “investor risk” arises as institutional investors pay increasing attention to the impact of the first two threats “on the traditional business models of the major oil and gas companies.”
“The crucial point to note about these risks,” Lewis emphasized, “is that they operate on a feedback loop, intensifying one another.”
Citing the Carbon Tracker Initiative, Laurence Tubiana, chief executive of the French Development Agency, pointed out that “from 60 to 80% of coal, oil, and gas reserves of publicly-listed companies could be classified unburnable” under a climate policy that is truly proportionate to atmospheric physics,
“Citigroup in 2015 estimated the value of these potentially stranded assets at $30 trillion in the oil sector alone,” Tubiana recalled. “There is, therefore, huge potential shareholder value destruction in oil companies pursuing business-as-usual strategies in a carbon-constrained world.”
So yes, the oil business has another bounce left in it. But when it comes, it will “not indicate a sign of recovery of the oil industry,” the EnergyPost forecasts. “It would be more of a ‘last gasp’ by the industry, establishing not much more than a last opportunity for those who do not own the lowest-cost resources to offload their oil-related assets for a favourable price.”