Just over six months ago, the consensus opinion was that US$100 /bbl oil prices would be here to stay for the long term.
For four years we saw oil prices hovering at around $100 per barrel and the world economy was doing ok.
The easy rationale was that Saudi Arabia, Kuwait and the United Arab Emirates would defend oil prices at this level as their economies had got used to the fruits of US$100 oil, and their production could be reduced, having been substantially above their historic averages. We, among many others, thought it likely that Opec would cut production to defend prices.
The Opec decision at the end of November 2014, essentially to defend market share, came as a surprise to many commentators. The decision makes it very clear that, for the time being, Saudi Arabia wants to maintain market share and put pressure on the US oil producers that have borrowed heavily and reinvested aggressively in new unconventional oil production over the past five years.
In many ways, it is not dissimilar to the market volatility brought about by the father of the US oil industry John D Rockefeller when he gave his higher-cost competitors a “good sweating” a century ago by driving oil prices down and putting them out of business.
So, the industry is in the process of adjusting to sharply lower oil prices, and it is not an easy adjustment to make.
There is no clarity over the short-term direction of the price of crude oil and there are divergent views between well-regarded energy companies and commentators on where crude will be in coming months.
At a recent energy conference we saw contrasting views between industry heavyweight, ExxonMobil, forecasting US$55/bbl oil for the next few years, and the darling of the US shale oil industry, EOG, forecasting a substantially higher oil price by the end of this year. Will the recovery in price be ‘U-shaped’ or ‘V-shaped’?
Energy analysts are no better. When oil was US$100/bbl there was very little difference between energy analyst forecasts, but now, as an example, there is more than US$30 a barrel of difference between the oil price forecasts for the end of 2015 of Francisco Blanch at Merrill Lynch and Paul Horsnell at Barclays.
The oil industry has many periods of over-supply in its history to draw on as parallels, but the key unknown this time is shale oil activity and how shale production will react to lower oil prices.
We see an oil market today that is well-supplied, which constrains price, but maintain our view that oil prices need to increase in order to incentivise significant new oil production over the medium-to-longer term.
US oil production has been growing at around 1.5 million barrels a day (near peak levels), Iraq production has improved, and there are overhangs elsewhere within Opec in the form of higher post-sanctions oil production from Iran and, potentially, greater production from Libya. These factors have put the 93 million bpd global oil market into oversupply of between 1.0 and 1.5 million bpd, causing the oil price to more than halve.