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The dilemma in the oil market

Almost two years after the oil crisis started, there is still an ongoing debate on how to overcome it. Agencies and big companies always have something to say in this matter, but what’s the right move to make?

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Those who refused to consider production cuts kept saying it and it might just come true: “Do nothing and the market will correct itself.” At the end of March, 21 months after the oil crisis began, the International Energy Agency issued a warning that suggests a price shock (one going in the opposite direction) might be lurking around the corner.

“We need a lot of investments just to stand still,” warned Neil Atkinson, head of the IEA’s Oil Industry and Markets Division. “There’s a danger we are reaching a point where we are barely investing upstream. If investment doesn’t resume in 2017 and 2018 we can see a spike in oil prices as oil supply can’t meet demand.”

Bingo.

Atkinson says the base line required to sustain the current level of production is around $300bn. He said the US, Canada, Mexico and Brazil are facing difficulties meeting that. Bloomberg names ConocoPhillips, BP and Chevron Corp., companies which have spiked more than $100bn in investments as well as let go thousands of workers, over the last two years as a result of sub $30 pb prices, a 12 year low. The consequence (or bonus) of this course of action is a reduction in glut. According to the IEA, there is scarcely any extra capacity among global producers.

In April OPEC holds another meeting (with the exception of Iran and Libya) to consider the calls to curb production – an event the IEA is sceptical about. “Among the group of countries, only Saudi Arabia has any ability to increase its production,” Atkinson told industry insiders in Singapore at the International Energy Week Conference. “So a freeze is perhaps meaningless. It’s some kind of gesture which perhaps is aimed to build confidence that there will be stability in oil prices.”

There is a significant unknown to consider of course – that of shale production. “If prices show signs of recovery,” said Atkinson, “encouraging marginal shale producers to stay in business or come back into production, that puts a cap on price growth and this is going to be a really interesting problem over the next few years.” ‘Interesting’ is one way of putting it. We’re pretty sure Ali Al-Naimi would put it another way.

A doggedly resilient shale market would also impact on the most solid growth hotspot for global oil producers. With predictions of continued growth in the Indian economy (8% per annum up to 2021) and subsequent increases in oil demand, Saudi Arabia and the US will be jockeying for position at the table. There are expectations that an extra million barrels will be added in 2017, backed by the strong fuel demand from the transport sector and it could rise if India takes a long-term decision to stockpile for fuel security purposes. This may factor into a decision later this month at OPEC’s meeting to postpone a formal decision on production.

However there must be some action. “Oil does not work at $50 pb,” according to the US consulting firm Oliver Wyman. “The price needs to be at least $56 pb or the industry is not going to see the investment required to offset impending decline.” It says it is time for forging new strategies and operating models to stay ahead of the profound transformation underway. The industry leaders must decide what is more important – dominate the market today and risk tomorrow’s supply, or come together for a smaller slice of the pie but a recipe for future growth?