Hamid Hamirani, Sr. Economist at Oman's Ministry of Finance Informs on Oil Outlook
Hamid Hamirani is the adviser to His Excellency the Minister Responsible for Financial Affairs in the Sultanate of Oman. In this June Paper, he presents a compilation of his reading over the last few weeks.
If only all this had not happened OR we had known. COVID-19 lockdown impact on the global economies did not only result in the hedge fund managers being on the wrong side of the futures contract, but also the high and mighty OPEC Plus, to reverse its oil production strategy within a short span of time. This makes it imperative for the decision-makers to have a good insight on the challenges that lie ahead in short-, medium- and long-term. The read below is compilation of my reading over the last few weeks.
Short Term
The volatility in short term is mainly due to disagreement over the production cuts between Saudi Arabia and Russia in early March this year. The over-production in April by Saudi Arabia Kuwait and UAE, together with the destruction of demand in March and April due to COVID-19 has resulted in an unprecedented increase in the global crude oil inventory which will take time to get to the normal levels.Things since then have settled largely due to OPEC Plus cuts in April and an exceptional decline in the non-OPEC producers like US Shale, Canadian oil sand etc...
The concern though is that despite of the global production cuts of around 14 million barrels a day the price has only moved into mid USD 30s per barrel. This is primarily due to uncertainty over how the reopening of the COVID-19 lockdown will play both in term of:
- Reemergence of the infection rates and deaths.
- And the pace of the economic recovery.
Right now looking at the oil futures until the end of the year the market while has improved still remains nervous as the Brent futures (to which Oman Oil is closely linked) is around USD 38.5 per barrel for 2020 and USD 42.33 for 2021.
Medium Term
If the price of oil rise, then US shale companies are likely to increase production. US shale provides job and energy independence to the US so it will always have the politicians support with easy money. President Trump has already made it clear “We will never let the great U.S. Oil & Gas Industry down”.
You can't kill the shale, you can only change the owners. In the US Shale Play, IOCs are buying service sector assets so that when they come back out of this, they're not going to have to pay a premium to oil & gas services companies - the likes of Halliburton because they're going to have those resources in-house and they're going to be at a controlled cost. And some of the companies are planning to use much higher accuracy through automation; for instance, automation of water. i.e. no human beings, just all automated. This will bring the breakeven cost of US Shale Oil much lower than what it is today.
However, if the economic recovery is slow it will put pressure on investments in oil. According to Norwegian Rystad Energy if the oil price remains in mid USD 30s there will be Capex spending cut of between USD 100 to 150 billion. Although there are around 70,000 oil fields in the world, approximately:
- 25 fields account for 25% of the global production of crude oil;
- 100 fields account for 50% of the production;
- And up to 500 fields account for 75% of cumulative discoveries.
Most of these ‘giant’ fields are relatively old, and many are well past their peak of production, a majority of the rest will begin to decline within the next decade or so and few new giant fields are expected to be found.
There are a lot of fragile states in Africa & Latin America that are heavily indebted and might not be able to service that debt and maintain their oil production. Venezuela, sadly is an example of this that not only were they not able to service their debt, there was a complete breakdown of society, leading to oil production collapsing completely. There are reservoirs in eastern Venezuela that aren't just damaged because the surface equipment has been damaged as people stole copper, and the supercomputers and everything out of lawlessness, but they have been physically damaged in a way that certain fields will never be able to be brought back on.
Countries like Iraq or a Nigeria are quite vulnerable to the impact of the COVID-19 lockdowns may have on their economy depending on how long the turbulence continues. It is not clear that they'll be able to continue their oil production.
All this will create a drag on the oil supply during the time when the demand is expected to pick up. This is perhaps why both Rystad Energy and Moody’s are projecting the oil price to rise to around USD 70 per barrel by the end of 2021.
Long Term
In long term the climate change: Environment Social Governance, is expected to reduce the fossil fuel consumption for energy production. Coal in the last three, four years has been pushed aside by a combination of, natural gas prices being cheap, together with everyone recognizing that coal is dirtier than natural gas, so naturally, it has declined. But what is astonishing is that it's gone back to the levels similar to those of 1980, which is pretty dramatic. I think this whole movement, which has done the same thing to coal, is going to happen with all hydrocarbons; it's just a matter of time.
University of California Pension Fund and Endowment Fund a few weeks ago announced that not only are they intending to divest more heavily from fossil fuels, but they are doing it in passive index holdings. This trend we're already seeing in Europe. The market capitalization ratio of the energy component of the S&P Index has gone down from 14% in 2014 to just 4%. BP, Total, Eni, are already taking a much more proactive stance to try to show that they are recognizing that there's going to be a transition. So the pivotal question is: will companies still be able to access capital markets to continue to invest in the oil that the World may need?
It is no wonder that the IEA (International Energy Agency) has come up with the most aggressive oil demand forecast for 2050: The oil demand will only be around 50 to 70 million barrels per day. I believe it will be lower. With such a reduction in the oil demand how the oil producers will fight for the market share. US sanctions have already crippled Venezuela, Iranian production and exports have been significantly reduced. Libya has unreliable oil production and this is all happening when the oil demand before COVID-19 impact was around 100 mbpd.
There is certainly a lot going on above and beyond just the oil price. Geopolitics, climate change, socio economic stability of the oil producers, access to capital and more importantly how the leadership of the G20 addresses these challenges will determine a fair price for Oil in the long term.
Hamid Hamirani is a member of II Network, to discuss the content of this article and further engage with him, comment below. The views expressed in this paper are his own.