Why we could see less than 30 USD oil again – part 1

So, OPEC has met and decided that the world is good as it is and no strategy change is needed. Who is surprised here? Who is expecting any shift from OPEC right now? They are not in the driving seat anymore, and if they still are in the seat, breaks are not working.

However, whoever hangs on the lips of OPEC executives (or indeed big oil executives) for getting the clues oil holds was always in for a bout of disappointment as those folks have led us into the mess we are right now in the first place. How do we believe in them sorting it out now? It’s like making the goat responsible for the lettuce bed.

Much more important than what those people think is – what are the core fundamentals this world is going to dance along for the next couple of years? And even more so how that is going to influence the oil price. Ain’t that what you want to know?

OK – now – oil has hit 50 USD again – happy days are here to stay. Let’s have a party.

Really?

I don’t like to spoil the fun easily, but we are sitting on a volcano that’s about to erupt and I have a feeling we have not seen the worst yet. Now, I know that this read is not exactly making the day of most O&G folks so if you are of the fainthearted type – please don’t read on. As what follows will hurt your feelings and I won’t let you blame me for not having warned you.

Sitting tight? Good.

Those who read this blog for longer than a few weeks will know that in June 2014 I proposed a wager. I said that WTI is going to be below 28 for at least 5 days before March 31st, 2016. At the time when I said that, WTI was a whopping USD 104. You will also know that I had lost my wager by the tiniest of margins as WTI was below 28 for 4 days – not 5. You will also know that I came closer to the truth than anyone else – and with anyone I mean anyone. Consulting firms, all banks, experts, oil majors, the EIA – they all were wrong. I also hit a number that has been just USD 1,79 shy of the ultimate truth as the absolute low has been at USD 26,21.

Now it’s time for another wager. I believe that by May 31st, 2017, WTI will have been lower than 25 for at least one day. This would mean that the current recovery is a shambles (a dead cat bounce as the finance folks used to say). I also predict that the second dive is going to be way more lethal than the last flirtation with 28.

Why do I think so?

Let’s concentrate on my prediction that this time it’s going to be much more painful, virtually lethal. The last dip was excruciating pain for many energy folks. So far, so good. However, conventional wisdom holds that as painful as it may have been – it must be over now. Oil has almost doubled since its low point at 26,21 (WTI) in the earlier months of this year and most energy analysts believe that the journey is the UP again. This means that all those projects and companies that have been more dead than alive at 26,21 USD, but that somehow managed to scrape by, can sell the current recovery as hope for better – later.

This got fingernail-biting bankers off those companies’ heels – for a while – as they also were able to justify the deep red investments on their balance sheets as salvageable prospects if enough time gets by. This means that much of the current superficial financial sanity in the world’s energy system rests on the belief that the worst is over.

How would those same people react if the message were – brace yourself as the worst is yet to come? They would probably wet their undies and race to exit this shit sandwich as soon as they can – thus fueling a race to the bottom and crashing many companies in the wake.

But you know that saying – snowballs are tackled best when they are still smaller. This means that it’s also still easier to tackle a very large snowball right now than a ginormous one later. And having a ginormous one later is what the current Ponzi-System style recovery lulls us into building up.

Let’s come to the fundamentals of the oil market. What are the prospects of oil going down to price hell again?

Those who believe in quick recovery seem to have forgotten the fundamental nature of the oil world. Oil is the decadal business. Very little of what is being decided today has any real and perceptible impact on the oil market today. I know that there are armies of EXCEL-wielding analysts showing you this correlation or that tipping point but rest assured, they are snake oil sellers. Don’t blame them either as they don’t know better. For the longest time (more than a decade) we were in everlasting growth mode and company strategy by KPI. Real strategy has long ago left the boardroom and big numbers rule as those big numbers also justified the obscene bonuses the C-suite allotted to themselves.

Problems, organic growth, and other risk management mechanisms would only have disturbed this gigantic party.

It takes ages (a decade most often) from first idea to oil production and sometimes a little longer. Just 2 years ago, the oil price was still 3 digits. This means that whatever significant has been decided over the last 24 months will not bear meaningful consequences for the next 5 to 10 years. You simply don’t feel this on the market. Except for the ginormous sums of money flowing down the value chain through the sheer cost of building those monster projects. This money often still fuels the impression that business is still healthy and that we need just higher prices to make everything nice again.

The oil price is a jittery thing as even a misbeat of the Saudi rulers’ hearts is interpreted and finds itself in the oil price but those are mere nanosecond jitters. A friend told me that a few 100.000 bbl of production more or less per day makes a difference in the oil world. Anyone having a strategy that looks beyond the balance sheet for the current year must necessarily ignore such ramblings for his Due Diligence of the fundamentals. But does he?

Just take a look at the Kashagan project in Kazakhstan as one particularly galling example of this. Developing this very large oil field took way more than a decade and it’s going to produce oil only from next year on. The money for developing it was sunk many years ago, way before the current low oil price situation came to bear. And still, it’s going to produce its black glibber and throw it on the market as shutting it down for lower oil prices does not make any sense. As said, the money is spent already, so they might just as well produce and salvage what they can plus hope for better times later.

There are many projects like this and the rig count fall in the US is not going to mask that. I love the shale industry and what’s happening in there and it indeed responds to different drivers than the conventional industry (much more reactive to price developments, much quicker cash-to-oil ratios, etc) but it’s still a sliver of oil on top of an ocean of conventional oil. This means that shale has a marginal influence on oil prices but the deep fundamentals are still being driven by the good old decadal projects.

However, we have just learned that last week the rig count was growing for the first time in many months. If companies in North America put more iron onto the drilling patch at USD 50 this means that this price level allows them to drill new holes and make money when doing so. This also means that costs for developing shale oil in the US must be lower than USD 50 at least in some plays. And if they put in more rigs at 50 they will also maintain stimulation at much lower price levels. Plenty of oil coming.

But at the same time, demand growth is not real. The biggest deception out there is that China is on a new, eternal buying spree and will suck the market dry. Really? Read more on that next week in part II.