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Vol. 21, No. 2 Week of January 10, 2016
Providing coverage of Alaska and northern Canada's oil and gas industry

Herrera: slow oil climb

Industry observer says low crude spurs growth, matches demand to supply

KAY CASHMAN

Petroleum News

It’s anyone’s guess what crude prices will do in the next five years. The Organization of Petroleum Exporting Countries predicts oil prices will begin to recover in the last half of this year, climbing to $70 a barrel by 2020 and $95 per barrel by 2040.

OPEC members produce about 40 percent of the world’s crude; more importantly, the cartel’s oil exports represent about 60 percent of the total petroleum traded on the world market.

The International Energy Agency sees the oil market re-balancing at $80 a barrel by 2020, “with further increases in price thereafter.”

Moody’s Investors Service significantly lowered its price forecasts for Brent and West Texas Intermediate crude in mid-December, amid a threat of a prolonged oversupply. The bond rating agency dropped its 2016 average price for Brent crude, the international benchmark, from $53 per barrel to $43, and for WTI crude, the North America benchmark, from $48 to $40.

Moody’s expects both Brent and WTI prices to increase $5 per barrel in 2017 and again in 2018.

As commodity prices continue to slide, the global oil and gas industry will reduce capital spending and work toward leaner budgets in 2016, Moody’s said, stating the obvious, in a recent report.

“Excess supply will continue to drag on commodity prices in 2016 in the global oil markets and the U.S. natural gas market,” Steven Wood, a Moody’s managing director, told the Wall Street Journal In December. “Furthermore, the potential lifting of sanctions against Iran could bring even more supply to the market in 2016, offsetting any expected declines in U.S. production.”

Iran looking to recapture share of market

According to Iran’s oil minister, Bijan Namdar Zanganeh, the country is trying to regain its lost share of global crude sales once sanctions are lifted.

“The oil ministry intends to boost Iran’s crude oil exports by an aggregate of 1 million barrels a day in two phases,” Zanganeh told the official Islamic Republic News Agency in December.

In the first phase, Iran will raise exports by 500,000 barrels a day within a week after the international sanctions are lifted, adding another 500,000 barrels a day in the second phase to begin six months later, Zanganeh said.

In the past 20 years when commodity prices dropped and industry experts were singing a song of woe for the long-term, Petroleum News turned to its favorite oil price guru, Roger Herrera, for his take on the situation.

Invariably, Herrera, a long-time energy observer based in Anchorage, predicted a short-term return to higher oil prices.

He was always right.

This time, however, Herrera is not optimistic about a fast turn-around.

He sees $40 oil possible by the end of the year, “if everything goes better than expected,” but Herrera was unwilling to forecast beyond 12 months.

He did say, however, that because low oil prices are good for the general public and businesses outside the oil industry, they eventually translate into more development.

More development in the economy, in turn, increases the demand for oil, causing oil prices to increase.

That said, he doesn’t see development catching up with the world’s crude supply any time soon.

In part, because it is a gradual process and the current gap between development and supply is very wide - and because cheap oil isn’t yet causing an appreciable decrease in the cost of living.

“This time, they seem to be taking their own sweet time,” Herrera says about the cost of goods and services.

But, he points out, there are some indicators that the economy is being stimulated by cheap gasoline: For example, U.S. automobile sales totaled a record 17.47 million in 2015, the biggest sales year ever, according to figures from automotive research firm Autodata showed on Jan. 5.

The 2015 total is up 5.7 percent from 2014, just passing the previous record of 17.41 million from 2000, per figures posted to Autodata’s MotorIntelligence website.

“The U.S. economy continues to expand, and the most important factors that drive demand for new vehicles are in place, so we expect to see a second consecutive year of record industry sales in 2016,” Mustafa Mohatarem, GM’s chief economist, said in a statement that was reported in USA Today.

“There’s no end in sight to those trends,” AutoTrader.com analyst Michelle Krebs said, per the USA Today report. “You’re going to hear the same broken record next year.”

It’s a slow process, but “maybe - maybe - in five years we’ll see a return to $100 oil,” Herrera says.

OPEC refuses to cut production

In the past two decades Saudi Arabia has reduced its crude production and used its influence within OPEC to convince other members to do the same, a move that has effectively bolstered oil prices.

But despite prices tumbling from a high of $114 last June to $35-something today, OPEC has refused to cut production, preferring instead to maintain its market share and drive out rival U.S. tight oil producers who have higher production costs - approximately $50 a barrel, as compared with less than $10 in Saudi Arabia.

Will Saudi Arabia reduce its output in the next year or so?

“I don’t see that happening,” Herrera says. “And why should they? This oil glut was brought on by shale producers from the United States. We nearly doubled our production in a very short time,” he says. (The U.S. produced 5 million barrels a day in 2008, EIA says; in 2014, 8.7 million barrels; and in 2015, the agency estimates 9.3 million barrels.)

“Why should Saudi Arabia sacrifice itself by significantly reducing its oil when America caused the problem? Why can’t the United States take responsibility for the solution? We’re largely responsible for the oversupply, for the drop in oil prices … therefore we should be shutting in some of our wells. Instead we’re expecting Saudi Arabia to do traditionally what they have always done,” Herrera says.

US tight oil production still increasing

The U.S. shale industry is holding its own, with output continuing to grow.

“New drilling is down, but it seems as though they can go in and re-frack wells and keep their production up,” Herrera says.

A year ago, OPEC, upset with the U.S. for creating an oversupply of oil in the world, decided to let market forces determine the price of oil, rather than its own production quotas.

Expectations were the U.S. oil industry’s production would collapse within six months; then 12 months; and now Saudi Arabia officials are instead predicting a gradual increase in U.S. tight oil production.

A recent OPEC report predicted production of U.S. tight oil will rise to 5.2 million barrels a day in 2020 from 4.4 million barrels a day this year.

“I think the resilience of U.S. shale, even with the pressure on it now, has really been one of the biggest surprises for the industry,” said Daniel Yergin, IHS vice chairman and long-time industry observer.

Saudi Arabia and Russia, the two other big producers of crude in the world, are also increasing output, adding more than 1 million barrels a day in the past year.

Not a pretty picture

“What we’ve created is a situation that is quite unique. We’ve never had an excess of oil in the world to this extent. .. Development sort of kept up,” Herrera says.

Even if crude prices return to the $100 level in five years or less, Herrera fears the world will be a much different place at that time.

“Lower oil prices could destabilize the governments of Russia and Saudi Arabia, which are heavily reliant on oil,” Herrera says.

“I presume that if the price of oil stays low, which I and others are arguing it will, then Russia is in pretty serious economic trouble. As a result, to deal with the social unrest Putin might be forced to become a complete dictator, the tradition in Russia.”

But, he wonders, “Would the rest of world accept Putin as a complete dictator?”

Saudi Arabia, he says, “is equally fraught with problems. They’ve got more money than God, but at some stage the money they’re burning will lead them to be in a very embarrassing position. They will run out of money. … It will not ease the political situation in the Middle East.”

About 97 percent of Saudi Arabia’s population relies on government handouts. “They don’t need to work. They don’t work. They survive because of this huge largesse oil money has provided. …

“They’re going to run out of money and does that result in revolution by the locals? Who knows, but for 40 or 50 years they’ve been relying on the government,” Herrera says. “They’re not terribly productive citizens or level-headed citizens. … So how will the Arabs in Saudi Arabia react to considerable tightening of the belt and having to work and do things which they’ve never had to do?

“In time development will catch up with oil production, but the world is not going to return to the situation of 5 years ago,” he says.

“That said, I can’t see any way that the price of oil will significantly change (in the next 12 months). Oh, it might go up to $40. … But it’s not going to surge to a level that would rectify the situation. …

“And if it doesn’t go up, a political upset in the Middle East and in Russia is almost a certainty,” Herrera says.

“It’s not a pretty picture.”



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