The Mid-Term Oil Price: The Need to Trigger Investments Must Eventually Pull Prices Up

The first factor which influences oil prices in the mid term is, of course, demand. The evolution of oil consumption in the coming decades will greatly determine the price level at which oil is supplied. Indeed, the oil price determines the profitability (or non-profitability) of new oil fields.

The International Energy Agency (2012) has come up with three scenarios to forecast the oil consumption evolution in the next two decades. The “Current Policies” scenario forecasts oil consumption evolution without any change to current policies and trends. It is the high-base scenario. The “New Policies” scenario forecasts oil consumption evolution taking into account the policy changes in progress which have a high chance to actually happen. It is the realistic scenario. The “450” scenario forecasts oil consumption evolution as it should be to meet global carbon reduction targets and limit CO2 concentration in the atmosphere to 450 ppm (Fig. 3.15).

The “Current Policies” scenario plans for an increase of oil consumption of 0.9% per year on average till 2035, which corresponds to an overall increase of 25% in absolute terms. This also corresponds to a yearly increase of 0.9 Mbl/d. The “New Policies” scenario plans for an increase of consumption of 0.5% per year on average, or 15% total increase in absolute terms over the period. This corresponds to a yearly increase of 0.5 Mbl/d. Finally, the “450” scenario plans for an average decrease of 0.4% per year, or 9% in absolute terms over the 2010-2035 period. This corresponds to a drop of consumption of 0.3 Mbl/d. The International Energy Agency forecasts are thus quite conservative, considering that the average increase in oil consumption in the last 3 years has exceeded 1 Mbl/d (EIA 2015). The trend definitely looks upwards.

The growth will mostly come from Asia, in particular China and India, as well as the Middle East to a lower extent. This considerable growth (70% in China, 124%

Oil consumption evolutions

Fig. 3.15 Oil consumption evolutions (© OECD/IEA, WEO 2012) in India, 40% in the Middle East) will be strongly compensated by the drop in consumption of North America (—24%) and Europe (—23%) over the same period, following the implementation of energy efficiency measures, in particular in the transportation sector. This is why in the end the global oil consumption evolution is expected to be limited. Of course, further disruptions can also happen. They will be described in Chap. 5. They actually correspond to some of the possible solutions to meet the “450” scenario and would lead to a more significant reduction in oil consumption.

In the end, government policies will be instrumental to shaping up a sustainable environment of constraints which will facilitate these transitions and influence the evolution of oil consumption. The current level of oil prices could have a negative impact on the will of governments and nations to actually make a change, as the situation yields an increase in economic growth at no cost. The drop of oil prices at the end of 2014 indeed yielded in 1 year a massive transfer of wealth from exporting regions to importing countries (Table 3.2).

Overall around 930 billion dollars of wealth were transferred. The figure is calculated using the actual flows of energy traded across regions (BP 2014) multiplied by the differential level of price between mid-2014 and mid-2015. It shows that the Middle East and Eurasia lost the most, while Europe and Asia benefitted the most. North America, being both a producer and a consumer, is not impacted at the same level. In the end, this massive amount of wealth will have an impact on high-consumption regions, driving economic growth and possibly discouraging some initiatives related to energy efficiency. This impact will however remain limited in North America. A number of studies (European Central Bank 2004; IMF 2012) showed the complicated relationship between GDP growth and oil prices. Basically, this relationship is non-linear. The impact of a strong increase in oil prices was found to have a strong negative effect on most oil importing countries, while a decrease actually affects only a few countries. The effects of oil price swings also differed greatly between exporting and importing countries, although not symmetrically. In the end, the recent oil price shock is creating favorable conditions for oil importing countries, which needs to be looked at case by case.

Besides consumption evolution, a second factor that can influence prices in the mid-term is production capacity. The “free” capacity of OPEC countries has significantly dropped in the last 30 years (Conca 2015). While it used to be as high as 15 Mbl/d, it went down in the recent years to around 2 Mbl/d. Production capacity is essential to meet demand. Oil demand increases year after year in almost all the International Energy Agency scenarios, except the “450” scenario. With none of the actual policies required to meet the “450” scenario having been put in practice, the likely trend of oil consumption in the coming years is upwards. Production capacity must thus be increased. This is all the more relevant considering that the “free” capacity of OPEC countries is not enough to compensate for the increase in demand, and taking into account the increased number of production disruptions.

Table 3.2 Wealth transfers across regions (BP 2014)

Billion USD

Transit energy to

Transit energy from

North

America

South

America

Europe

Russia/

Eurasia

Middle

East

Africa

China

India

Asia

Australia

Total

North America

X

22

18

0

2

3

4

3

6

0

-57

South America

33

X

7

0

0

0

12

13

7

0

-72

Europe

14

4

X

2

5

11

0

0

9

0

-46

Russia/Eurasia

10

0

116

X

5

1

17

1

16

1

-167

Middle East

42

3

40

0

X

7

61

49

174

3

-379

Africa

19

7

58

0

0

X

26

13

7

3

-133

China

0

2

0

0

0

0

X

0

9

0

-13

India

1

2

3

0

7

4

0

X

7

0

-24

Asia

3

1

2

0

1

2

13

2

X

13

-38

Australia

0

0

0

0

0

0

1

0

4

X

-6

Total

122

41

245

2

20

28

134

81

239

20

933

Production can be expanded provided it makes economic sense for oil operators to do so. The actual investment is highly dependent on the type of oil produced. Light conventional oil usually requires lower investments than deep-water, arctic, or most unconventional oils. In addition, many exporting countries use part of the economic rent generated to subsidize other areas of their economy. This is the case in Middle East and in Russia, where a price of the barrel as high as one hundred dollars is required to balance the respective government’s budget. Taking this into consideration, the investments that these countries can afford become a matter of careful selection of priorities.

Figure 3.16 maps conventional and unconventional total retrievable reserves volumes per region (© OECD/IEA, WEO 2012), as well as the corresponding incentive cost, the price at which it becomes relevant for an operator to start developing new fields (Advisor Perspectives 2015). The cost of unconventional oil development is considered in many regions where data is missing as equivalent to the one in the United States (this assumption remains to be proven). Also mapped on the graph are the government’s budget breakeven price levels for the most important exporting countries (Knoema 2014; Energy Matters 2014).

An analysis of the graph shows that, at a price of 50 USD/bl (September 2015 baseline), Middle East countries are essentially incentivized to develop new fields. Some fields in Russia and Africa could as well be developed at this oil price level. There is a disconnect between sources on the incentive costs for shale oil in the United States, with price ranging between 60 USD/bl (BNP 2015) and 80 USD/bl (Advisor Perspectives 2015). The shale oil industry in the United States is nascent and has been growing extensively, with limited attention to efficiency thus far. Given the very short payback period and the fact that shale oil industry in the United States is made up of many small players, it is extremely likely that the level of

Profitability of oil production investments

Fig. 3.16 Profitability of oil production investments (Advisor Perspectives 2015; Energy Matters 2014; © OECD/IEA, WEO 2012; Knoema 2014) incentive costs will go drastically down in the coming few years, thanks to the triple effect of profitable wells’ selection, industry consolidation, and the development of efficiency measures.

If many conventional fields can still be developed with a relatively low oil price, the governments’ budget breakeven price (Russia, Middle East) is much higher than the actual oil incentive production cost. This puts the balance of the budget of these countries at risk, and may hamper the further development of new fields in those regions to a certain extent because of arbitration between long-term development of production capacity and the distribution of social benefits.

In the end, the current oil price level, if a result of the current imbalance between offer and demand, shall rise up again progressively, in order to fund the necessary investments that will be required to sustain the likely growth of oil consumption in the coming years. It is though very unlikely that oil prices get back to the historical levels reached in the past 10 years. All the experts tend to believe they will recover towards 60 USD/bl in 2016 and probably higher later on (Knoema forecast 2015; Advisor Perspectives 2015; Makortoff 2015; Sharma 2015; BNP 2015). This should be enough to trigger the necessary investments to meet the rising demand.

 
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