Monday, November 2, 2015

Price of oil may recover ONLY one more time...

As the Oil and Gas industry is going through a forced hibernation, everyone is trying to estimate how long the current low price environment will last. At the same time, no one has any doubt that prices will eventually recover and things will go back to normal with a fast ramp-up in drilling activities with higher risk tolerance for capital deployment. Interestingly, some analysts suggest that the current low price environment may be due to the approximately 1,000,000 barrels per day of oversupply which is causing an inventory buildup and is depressing global oil prices.
World Supply-Demand_July 2015
If it is true that such a small (<1%) oversupply can result in market instability, then I suggest there are a number of incoming changes on the demand side of the market that will make the next oil price recovery the last we may ever see (I am not including regional instabilities or conflicts in my assumptions).

Here is why I think this is possible.
The current oil demand predictions dramatically underestimate the impact of energy efficiency going forward and the growth of electric/hydrogen transportation

Efficiency is a very complex issue and I will tackle it in a future post, however it is primarily based on the assumption that new global awareness of climate change will drive reduction in GHG emissions, and the easiest way to accomplish this is with efficiency improvements.

Let me explain the impact of the electric/hydrogen car.
1,000,000 barrels of oil per day are used by approximately 30,000,000 small cars, primarily for city driving assuming 60km/day and 8l/100km fuel consumption. At the same time electric vehicles are making headway on the market. Today the global penetration of the electric car is around 700,000 cars, 35 times more than in the beginning of 2010 when there were less than 20,000 electric cars globally. The International Energy Agency projects 20 million electric vehicles on global roads by 2020 (
Based on the current commitments by top car manufacturers and assuming current low oil price it appears that may reach 30 million (primarily electric and some hydrogen) cars on the roads in the next 7 years.

China is a wild card and if the government brings even stronger mandate to increase domestic production of electric cars, China may overtake the rest of the world with EV production by 2020. Just look at the amazing job they are doing with adoption of renewables in the last 2 years.
Let me be clear, oil and gas are very valuable resources, not only as a source of energy but as a source of hydrocarbons for everything we use in our lives. Yet, when oil prices recover, it will make it so much more attractive to invest in electric and hydrogen transportation and in renewable energy generation which will only lower the levels of long term demand for oil. In the next 10 years, unless oil and gas companies reinvent themselves, only those who invested early on in process efficiencies and are in plays with a slow decline and high reserves will do well in another lower price environment, while players with high cost and energy intensity or those with fast declining production will have a very difficult time.
Some of us may hope for one more run and a quick exit at the top of the market, on the other hand I would suggest let's not waste the current market environment which happens only every 4-6 years and lasts only about a year. We should use the current conditions to provide motivation to improve our cost structure, build resilience and invest wisely in long term, efficiency driven projects. The key is to make an investment that results in low opex to let us ride low prices and generate great cash to re-invest in the long term when prices are high.
It is time to switch from growth in barrels per day to growth in profitability from the barrels we already have. It may not seem as glorious as bringing more volume on at any cost but in the long term it will be the best thing we have ever done!
So where does this leave oil and gas prices, market stability and the future of oil and gas companies?

I may be wrong in my predictions yet no oil company can go wrong by improving their cost structure, regardless of what happens to oil prices!

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