This month our coverage has focused on the Middle East, a region rich in hydrocarbons and culture. These hydrocarbon resources will be discussed in great detail at next month’s GEO 2016 conference in Bahrain.
This biennial event, organized by AAPG with support from the Society of Exploration Geophysicists and the European Association of Geoscientists and Engineers is a prime opportunity for geoscientists in the region to gather, learn and discuss how best to find and develop these resources.
But the Middle East is also a region experiencing significant geopolitical tension with the continued and expanding conflict with ISIL and the re-entry of Iran onto the global stage with the lifting of economic sanctions that had been in place for decades.
The region is also experiencing economic upheaval with lower crude oil prices dramatically increasing budget deficits in many countries at the same time as they seek to diversify their economies.
Events and trends in this part of the world can have dramatic impact on our industry and profession. And we’re seeing it right now in crude oil prices.
The slide in crude oil started late last year and has accelerated in the past month. As I write this column, the WTI price is hovering just over $28 a barrel.
Everywhere I go and in every conversation I have with AAPG members, sooner or later – and it’s usually sooner – I’m asked what I’m hearing about the duration of this low price cycle.
We’ve all heard the old saying that prediction is difficult, especially of the future. But with the news cycle full of stories of layoffs in the energy sector, bankruptcies both occurring and looming, and a global supply glut, it’s hard not to get swept up in the panic.
The price of oil is controlled by many variables, but the four most important are:
- Supply.
- Demand.
- Risk.
- Currency effects.
Unlike me, analysts at the U.S. Energy Information Administration (EIA) are in the prediction business. And while they do not, as far as I know, have special or secret information, they do have a systemized approach to monitoring and using data to develop price forecasts.
Supply and Demand
When you look at supply it’s clear that the world is producing more than it’s consuming. EIA’s January 2016 Short Term Energy Outlook reports that global oil inventories grew by 1.9 million barrels per day in 2015 and they expect that trend to continue in 2016 with inventories growing by an additional 0.7 million barrels per day.
OPEC supply in 2015 averaged 31.6 million barrels per day with production increasing 0.7 million barrels per day in 2015 and EIA forecasts an additional 0.5 million barrels per day increase in 2016. The effect of Iranian oil reaching global markets may change these numbers. EIA expects Iran to grow its production by 0.3 million barrels per day in 2016 and 0.5 million barrels per day in 2017.
Non-OPEC supply increased by 1.3 million barrels per day in 2015 but EIA forecasts a decline by 0.6 million in 2016.
This supply growth has been driven largely by U.S. unconventional resource developments, which experience rather rapid production declines and don’t require the long investment cycles of large offshore installations, for example.
The world is producing more oil, and that is pushing crude oil prices lower.
But the world is also consuming more oil.
In 2015 the EIA estimates the globe consumed an average of 93.8 million barrels per day and they expect that demand to grow by 1.4 million barrels per day in both 2016 and 2017.
Think about that number: 93.8 million barrels per day is roughly 1,085 barrels per second. And, while demand growth may be slowing, it’s still growing year after year as people are born and begin consuming energy, as economies grow and people seek higher standards of living.
Eventually, this additional demand will sop up the excess supply.
Risk and Currency
Risk is another variable that hovers over crude oil markets.
A disruption of supplies to crude oil markets can quickly cause prices to spike. Current prices indicate that the market doesn’t seem to fear a disruption, notwithstanding the regional geopolitical tensions. But, events have a history of proving the market wrong.
Finally, a strong U.S. dollar is pushing down crude oil prices. Currencies do not have an absolute value, but rather are valued against something else.
Crude oil is valued against the U.S. dollar, and if you plot crude oil prices against the U.S. dollar index over the past five years, you see a strong inverse correlation between the two: As the dollar weakens the price of crude oil rises and as it strengthens the price of crude oil drops. That correlation is particularly pronounced today.
Many variables control crude oil prices, but these four are the most important variables.
Low prices cure low prices in commodity markets. I don’t know when that is going to happen, but our job is to be ready when it does.