Is the oil price flat-lining?
August 16, 2016
Perhaps it’s the geology that does it, but oil is one of those markets that tends to obsess about peaks and troughs: has the price bottomed out? have we passed peak oil? which could go some way to explaining why the current situation feels so unusual. If you look at market consensus views out to 2020, the line is, well, flat.
Ever since the price ‘troughed’ at $28.66/bbl in January 2016, the market has been speculating about when it would go back up again, how quickly it might rise, and where it might ultimately settle. By June 2016, the market consensus views of $100/bbl for 2020 in June 2014 had fallen to the mid c.$65/bbl. Investment decisions were put on hold, and new capacity delayed, waiting for ‘normality’ to return. Thus far, it hasn’t.
What both forecasters and futures are telling us is that it might be a good while longer before the price rises significantly, which leaves a significant percentage of the industry unprofitable in the meantime. ‘Lower for longer’ continues to be the most likely prognosis at the moment, but the current environment may take some adapting to, not least because short-term volatility is up, even if the longer-term prognosis is flatter than it’s been before.
So what’s driving this? We know what drove the price down in the first place, but what’s keeping it there now?
Well, unsurprisingly, the answer is more complicated than the question. In terms of the big, simple factors, the world economy is an obvious one. The slowdown in China had a big impact – in part because it took everyone by surprise - but elsewhere growth is steady, if not spectacular. But even if demand holds up reasonably well, it’s not necessarily having an upwards impact on the oil price.
Supply issues are one explanation for this. The oil market is notoriously – and understandably – inflexible when it comes to supply. Oil fields can’t just be ‘turned off’ when the price falls, even if that means operating at a loss. The high cost of decommissioning thus play a very big part in decision-making. Likewise, the Russians and Saudis (among others) have so far not shown a willingness to reduce production, which the cynics have suggested is less a pricing strategy than an attempt to counter the competitive threat of US shale oil; only thus far, the shale oil sector has proved to be surprisingly resilient. Taking all these factors together, there are now significant surpluses, not just of crude but of products like gasoline and jet fuel – according to the FT, US stocks are 12% higher than they were a year ago.
If ‘lower for longer’ is the reality – and we think it probably is – then the industry is going to have to find a way to thrive in that environment. Those with longer memories will remember that this has happened before, and those with longer careers will have actually done it. There’s already been a sustained and successful focus on costs; what the industry needs now is less a change in operating models than a change in mind-sets: it needs to survive and prosper through uncertainty, both in terms of day-to-day working and by finding a way to make the longer-term exploration and development investment decisions that both the world and the sector will soon need.
How is the oil price affecting your business? Have you seen an impact on your ability to access funding, are you rethinking your strategy for the long term or are you thinking about value implications? Either way, we would be happy to discuss. Please contact us using the details below or schedule a meeting to discuss your situation in confidence.
See our market commentary which looks at the issues raised above in more detail.