The perceived “supply overcapacity” there has been in the market, ultimately the natural decline curve, coupled with the shelving of investment in new production, will see that situation reversed quickly. This of course ignores any geopolitical tensions that there may well be on the supply side, especially in the Middle East where an all-out war between Saudi Arabia and Iran will result in one winner – and it won’t be Iran.
There are so many variables that impact the oil price, but our contention is that the supply side isn’t as robust as people believe it is, and this is only exacerbated the further out you look. We have often stated that there is a scenario that says that within two years the market is going to be worried about bringing on the projects that were shelved in this price environment because there is a perceived shortfall. We believe that the recent oil price strength is the start of that process. It shows, in a small part at least, that the effect of the decline in rig utilisation rates is beginning to have a marked impact on the relatively higher decline rate unconventional production, which needs regular intervention to maintain production rates, or offset the high initial decline rates.
While we have focused on supply, our recovery has assumed that that demand remains at current levels. What is a real unknown, especially at the moment, is the demand side of the equation. Again, here too history would generally support higher prices as oil demand is an inelastic driver (as it used in so many things from household plastics through to transport fuels) the real question is going to be to what extent global growth accelerates from these levels. Changes in demand tend to vary between -5% and +5%, with the extremes of decline only precipitating from catastrophic contraction in GDP.
If we balance this against the fact that supply will naturally decline at between 8 to 10% if no investment is made, then on balance, the further out we look, assuming we hold the current investment cycle steady, we believe the supply imbalance will become. However, we also accept that this imbalance is not quantitative, but qualitative, they market will have to perceive that there is a looming shortfall for it to impact the oil price.
Whilst we cannot rule out further downward legs in the oil price, we do believe that the current oil price environment will be seen as the downward leg of what generally will be an upward progression.
While like all people in industry we’re concerned about the current price environment, but we are less concerned about the oversupply in the marketplace beyond 12 to 18 months, simply because the contraction in investment will see the natural decline rate associated with existing production start to impact the overall supply levels. It is important to remember that this is distinctly different from nameplate capacity, and is set at the front end engineering and design stage.
2016 will be a transitional year, not least because there likely to be casualties, but we believe that it will also be the year that sees the start of what we have previously stated that “this leg will be seen as a relatively short lived down leg in the context of an upward saw tooth growth pattern,” but the one thing you can always guarantee with oil price estimates, that they will be wrong – its more about the direction.
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