Are we in an oil bust worse than the famous crash of 1986? The investment bank Morgan Stanley thinks so.
Oil companies have scrambled to cut costs and shore up their financial positions, and the industry has adopted the mantra that prices will be “lower for longer”. But with no consensus about how much lower for how much longer, executives have to steer a difficult course between riding out the storm in the hope of an upturn, and panicked overreaction.
Analysts polled by Reuters suggested Brent crude, now below $50 per barrel, would average $60.60 per barrel this year and $69 next, while the International Energy Agency foresees a recovery to $73 by 2020. But after oil prices had modestly recovered from January’s lows, the renewed plunge last month burnt several hedge funds.
Bearish factors abound. The continuing growth in Iraqi production, historically high Opec output led by the Saudis, the prospect of a return of Iranian crude, and future growth in Mexico as its industry opens up, collide with a tepid Chinese economy and a weak outlook for most commodities.
But Morgan Stanley’s comparison with 1986, although technically accurate, seems misleading. Back then, prices had already been dropping for five straight years before they plummeted. Opec spare capacity was 13 million barrels per day – 15 per cent of global demand – which took a generation to work off. Surging non-Opec output from the North Sea, Mexico and Alaska met consumption in steep decline owing to the increased use of other fuels.
Compare the current situation, when Opec spare capacity is only 2 million bpd or so, virtually all in Saudi Arabia, global demand is anaemic but growing, and non-Opec growth has been led entirely by North American shale projects, now beginning to show the effect of a year of declines in drilling. The fall in oil prices has been sharper than 1986 but was not preceded by a steady decline from a peak. And even at $50 per barrel, oil still seems valuable compared to 1998 when, adjusted for inflation, it was below $19 per barrel.
Oil companies have already cancelled $180 billion of spending on 46 planned megaprojects, particularly in high-cost areas in deep water and Canada’s oil sands. The abandonment of ageing North Sea fields, and the deferral of exploration in new areas will weigh on future production.
New debt and equity financing for US shale companies, abundant earlier this year, now seems to be drying up. They are considering asset sales, as are some of the super majors, including BP and Shell, offloading ageing fields; firms seeking to raise money to develop new discoveries, such as the UK’s Tullow; and Chinese corporations who overexpanded internationally in the past few years. But if everyone is a seller, who will be a buyer?
Even at $50 per barrel, prices are perfectly adequate for many projects to go ahead, if the industry can get some control over its costs. It has so far been more sensible than in previous busts, managing to retain skilled technical staff despite layoffs, reducing supply chain expenditure, improving technology, particularly in shale drilling, and beginning to reshuffle portfolios towards lower-cost fields, as with Shell’s purchase of BG, and wider industry excitement about Iran.
Governments and labour unions have to play their part. In countries from Canada to Norway to Australia, taxes, regulations, environmentalist obstructions and pay rates have swollen to absurd levels. One oil executive quoted by Reuters reportedly maintained his company would never build anything in Australia again unless labour laws were reformed.
Although prices should increase somewhat from today’s levels, no one – rightly – is betting on a return to $100 per barrel oil. Severe though this slump is, well-run companies should come through it stronger. But for the sake of future demand, the industry needs to start thinking how to resurrect, and finance, some of its $180bn of lost projects.
Robin Mills is the head of consulting at Manaar Energy and the author of The Myth of the Oil Crisis.
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