The Oil & Gas Industry: What Next?

Before we look ahead, first a look back at some of the key Events which shaped the Oil & Gas Industry After all, the industry does run on History Matching Models!

1859: Drake’s well – considered the start of the modern Oil & Gas industry

1911: Winston Churchill, then First Lord of Admiralty, ordered the entire British naval fleet to be converted from being coal powered to oil powered. A seemingly unwise decision at the time, as coal was mined within the British Isles while oil was imported. The decision was vindicated in the World Wars and amongst its side results led to the creation of bp and also drew up the maps of the modern Middle East.

1933: Standard Oil of California managed to outbid the Anglo-Persian Oil Company of Britain for an entry into Saudi Arabia. An event with huge geopolitical ramifications. Later the company would become Aramco.

1959: A meeting between the Saudi Oil Minister, Abdullah Tariki and Venezuela’s Minister of Mines & Hydrocarbons, Juan Pablo Perez Alfonso on the sidelines of the Arab Oil Congress in Cairo, which eventually led to the creation of OPEC.

1983: The New York Mercantile Exchange introduced the Futures Trading in crude oil. A decision which broke up the hegemony of the likes of OPEC and major companies in determining the price of crude oil. A few years down the line it also resulted in quirks like crude oil trading in the negative!

1997: Nick Steinsberger, successfully applied the fracking technology to extract oil & gas from shale – the technological development needed for the US Shale boom considerably reducing its dependence on external crude supply.

2015: COP21 and Net Zero targets - countries agree in principle to reducing their emissions to stop the average global temperatures rising beyond 1.5 C.

2020: Covid-19 pandemic brings the world to temporary halt, drastically reducing demand. Certain analysts even conclude that “peak oil demand” has been reached (how wrong were they!)

So what next? 

On one hand, Climate change concerns and net zero ambitions – there could be a sudden decision to switch the transport fuel from crude oil based to electric and/or hydrogen based and for power generation to renewables/nuclear etc. On the other. increasingly strained global supply chains may lead to increased exploration within currently oil deficient countries.

And I get a feeling that both paths will go hand-in-hand for the coming few years. Not sure when the divergence for one or the other will take place. 

Certainly, interesting times ahead for the industry!

The Big Oil Drop: Free fall continues...

Almost a year back, I had written about the falling crude prices. Since then the free-fall has continued with oil trading in the low to mid 30s. Alarm bells are ringing across the industry. The time for trying to figure out the reasons for the slide is long gone, though everyone has their own. The sharp slide is already having its impact. Projects worth nearly $35 Billion have been shelved; 200,000 jobs have been cut, the M&A market is warming up for the bloodbath. And the situation is likely to worsen. 

The US Congress has agreed to allow sale of crude outside US lifting a 40-year ban. The Shale boom made US less dependent on external producers. Which was one of the main reasons for bringing the prices down. However with prices down, the producers are in for a hard time, some having shut shop, most cutting activity levels to the bare minimum. Thus the US Congress decision is an attempt to ease the producers as their domestic market is already having a glut. This move might stabilize the US market but is unlikely to lift the prices.

The lifting of sanctions on Iran is likely to bring more cheap oil in the global market this year. Thus putting more pressure on the oil producers. Supply increases further with demand staying same or even worsening given the global economic slowdown.

The sharp drop has resulted in Saudi Arabia having a huge deficit in its budget. The Saudis, who are the only ones with swing capacity, have steadfastly refused to cut production to boost the price. Instead they have taken an interesting decision to publicly list Saudi Aramco.The listing of the world's biggest company could be the biggest financial event of the century, making up quite a bit of the Saudi deficit. Although it would also open their economy to more scrutiny, something which is against their secretive ways. But then tough times do call for drastic measures.

The emergence of Australia as a source of LNG would shift the direction of the global LNG trade away from Qatar. However the low prices have resulted in delays in some of the projects. Thus enabling Qatar to retain its hegemony for a while longer. Meanwhile, Qatar has been doing its bit to retain its market renegotiating supply contracts with the likes of China and India.

Then, the Paris agreement on Climate Change. If every country keeps their end of the promises, their would be shift from hydrocarbons to alternate energy sources. However, the low crude prices have made the alternate energy sources less attractive. We are reaching a stage where the oil is unlikely to run out but environmental concerns would reduce its consumption.

However, the tensions in the Middle East over Syria and the Saudi Arabia-Iran stand-offs might spike the prices up. Throw in further uncertainties like the possibility of Saudis acquiring a nuclear deterrent from North Korea or Pakistan, further escalation in the so called fight against Islamic State (which has captured a big chunk of the oil trade) or the migrant situation blowing up in Europe  But hoping for a war to jack up prices is certainly not good karma. 

Low prices are welcome news (for now) for an energy-importing country like India. The export bill reduces and with it the foreign exchange outflow. However, it comes at the cost of its domestic production which needs a much higher price to be commercially viable.

Times certainly are tough for the people in the oil sector.

Falling Crude Prices

Crude prices have been plummeting down since the middle of this year

Crude prices are now dipping the $60/barrel mark, much below the $100-120 range in which it had been moving for the past few years. Chief reason for the collapse is being supply outpacing demand (basic economics). Quite a few reasons have been attributed to this.

1. The Shale supply has enabled US to become self-sufficient (for now) and hence it doesn't need to import further.
2. Economic slowdown in Europe which is still not fully recovered from the recession.
3. The OPEC cartel is not united. And Saudi Arabia, the only ones with the spare capacity, are unwilling to cut production.

While lower fuel prices seem to be a good thing at first sight, this sharp dip in prices will have a major impact all round the industry.

1. Revenue calculations gone haywire, not just for the big oil companies but also for governments who have a substantial part of their budget sourced from taxes on oil & petroleum products.
2. Quite a few upcoming projects have been put on hold because the economics don't work out anymore. The projects become viable only if the costs go down. The supply chain generally lags behind the crude prices by a couple of Quarters, hence the projects might see quite a lengthy delay.
3. Marginal plays (e.g. Deepwaters, Unconventionals etc.) which had opened up due to higher crude prices may have to be put on hold. 
4. The alternate energy sectors (solar, wind, bio-fuel etc.) have to compete with these lower prices. This certainly delays their arrival as a big energy source.
5. Consolidation in the oil industry - Many players may be put out of business. Even the big companies are feeling the pinch. The second largest oilfield service provider Haliburton has bought Baker which was the third largest service provider. The M&A market may become quite busy in the days to come.

Normally when the prices have fallen the Saudis have intervened. They have cut production reducing supply. But this time they have chosen not to act.

Quite a few conspiracy theories are going around on their possible motives. The most obvious one is to destroy the competition. Saudi crude is available at much lower production costs than Shale or deepwaters. So when prices fall dramatically the Saudis will be the last to feel the pinch. 

Below are some of the theories doing the rounds. Most of them have less to do with economics but more to do with geopolitics.

1. Destroying US Shale - US Shale boom is considered the chief reason of this price drop. Ironically this boom happened only because the prices had breached the $100/barrel mark in the first place. Now that the Shale industry is well developed, we have to wait and watch how long they can hold up.
2. The OPEC cartel has seemingly run its course. The Saudis are the only ones with any swing production capacity left. So there is a theory that they will let the prices drop till the other OPEC members take a hit on production. Probably leading to the demise of OPEC.
3. Collusion between US and Saudi Arabia to stop the further development of the Russian oil industry. Russia may have even bigger reserves than Saudi Arabia but its more difficult to access, thus needing higher costs to sustain. Russian rouble is already in trouble and interest rates have been boosted up from 10.5 to 17% in Russia. 
4. A pre-dominantly Sunni majority Saudi Arabia does not want a Shia majority Iran to get oil revenues. Plain and simple.

Many theories doing the rounds. But oil prices have a major impact on world's economics. Falling oil prices will reduce inflation, creating more spare cash, which will be hopefully pumped back into the economy causing the economy to boom again, creating more demand for oil and pushing prices up. But this cycle will require at least a year's time. And during this period the industry may have already undergone a drastic upheaval.

Interesting times are ahead not just for the worried oil industry but also for the world economy as a whole. We will have to wait and watch what impact this churn has on the energy industry.

150 years of oil industry

Pic: Drake's Well & Edwin Drake

The Date: 27th August, 1859

The Place: Titusville, Pennysylvania, USA

The Man: Edwin Drake

The Event: Oil struck at a depth of 69 feet. The first ever producing oil well is drilled leading to the birth of the oil industry.

This has to be one on the most impotant discoveries in the history of mankind. Without this natural energy resource, the entire industrial revolution and the technological advancement of the past one and a half centuries would not have taken place. Just imagine a world without oil. We would probably still have been living in the middle ages. The discovery of underground crude oil reserves would surely rank alongside mankind's greatest discoveries, like fire, agriculture, the wheel, written language etc. And over the last 150 years it has been the one industry with the maximum impact on the geopolitics and the global economy.

As the indutry celebrates 150 years of its existence, I salute the man who made it all possible. Col. Edwin Drake, hats off to you sir. After all that single discovery of you has had a very powerful impact on what I am today.