October 26, 2016

Change the record OPEC! Why its planned production cut will fail

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You know how it is when you go somewhere and spot someone famous? Seeing a celebrity outside of their familiar setting (maybe in their normal day clothes rather than their stage gear, maybe a bit older or heavier than you remember) can make you question whether it really is that person from the telly or the world of sport or music.

I was on the London underground recently on a family holiday when my wife spied a guy a bit further along and opposite us in a black t-shirt and jeans. It was Les McKeown of the Bay City Rollers. Definitely. We double-checked his image on Google.
 
Remember the Bay City Rollers? They sang ‘Shang-A-Lang’ and they ran with the gang in the early 70s when tartan was everywhere, guys sported long hair and platform shoes, and Scotland qualified for World Cups.
 
Remember the three-day week of 1973 and having to light our homes with candles because of energy shortages? I certainly do. I had recently been the recipient of a pet turtle that needed 24-hour light and heat: once the power cuts came in, the writing was on the wall for the poor creature.
 
And who was to blame for the power shortage? OPEC’s Arab members mainly, badged as the Organisation of Arab Petroleum Exporting Countries, through their oil embargo as part of the Yom Kippur War against Israel.
 
Contrast the strength and power of OPEC then, to its position now. Throughout the seventies, eighties, nineties and even into the noughties, when OPEC spoke we listened. When they wanted to increase fuel prices they reduced production and we paid more for our petrol: when they wanted to bring prices down they opened the taps again, and in that way, they regulated the oil price for years.
 
Regular readers of my blogs will be well aware of the reasons behind the current low oil price: basically, less than expected demand for oil from Asia, due to a cooling off of economies there, the growth explosion of the US shale industry and OPEC’s refusal to yield market share through scaling back production.
 
After a horrendous two years, which have seen the UK oil and gas industry shed approximately 120,000 jobs because of the low oil price, OPEC announced recently that it would look to trim production from some member states to between 32.5 and 33 million barrels a day, a drop of some 750,000 barrels-a-day on its August production figures.
 
The news, which caught most analysts by surprise, has seen oil prices climb from around the US$47 mark to US$52 per barrel, and the rise has been passed on at the petrol pumps accordingly.
 
The details of the deal will be announced at OPEC’s regular six-monthly meeting in Vienna on 30 November and, if everything goes to the cartel’s plan, that will trigger greater confidence in oil and a further price increase.
 
You could sense a sigh of relief in some quarters, that in this huge, marathon oil-based poker game between Saudi Arabia-led OPEC and the US, the Saudis blinked first. Many in the general, non-oil and gas based media, made much of the news. It seemed like happy days were here again.
 
But, for one reason or another, the majority of commentators, analysts and industry leaders in the oil and gas industry just don’t buy it, and I agree with them.
 
Here’s why. Let’s go through three of the problems OPEC faces.
 
One. The production cut will not be uniform across each of the 14 member countries, meaning that some countries will face larger reductions than others, and it has been suggested that some members, such as Nigeria and Libya which have experienced industry turmoil over recent years, may escape a cut altogether. Iran, who recently returned to the international trading fold, is keen to pump out as much oil as possible, as is Iraq. How will OPEC deal with uncooperative members? How will it develop an effective and sustainable plan for production, and can the member states be trusted to stick to it?
 
Two. OPEC’s members produce about 40 percent of the world’s crude oil, meaning the rest comes from non-OPEC countries such as Russia, North America and, further down the list, the UK and Norway. Russia has indicated a willingness to cooperate in OPEC’s efforts to stabilise the market but, despite Saudi Energy Minister Khalid Al-Falih stating that many nations were willing to join in, Mexico and Norway have said they won’t and we can safely assume that the North Americans won’t either. What new US president would be prepared to curtail a major industry with the potential to create thousands of jobs and cut gasoline prices at the same time? Yet, how successful would an OPEC production cut be in stabilising prices without similar concessions across the globe?
 
Three. We are no longer in an industry driven by supply and demand economics. The rapid development of the North American shale industry has taught us that supply is no longer an issue, and will not be for generations to come. I remember one senior executive claiming that we would never run out of oil and, while I don’t understand the logic of that argument in relation to a finite resource, I do get the sentiment. The days of peak oil are over.
 
A supply shortage is no longer an issue in large part because of the vast and vibrant US shale industry, which is tuned to respond rapidly to the slightest tremors in profit and loss, and oil price. Where massive deepwater projects can take years to plan, design, engineer and deliver, shale rigs can be set up in weeks and shut off just as quickly. As the oil price has crept back up, so the number of new rigs in the shale plays has increased. Many companies in this sector have proved their resilience to a low oil price and have introduced new technologies to improve production performance per rig. Every US shale field is showing an increase in efficiency per rig – up to as much as 27 barrels-per-day on Colorado’s Niobrara shale formation.
 
The growth and commercialisation of renewable energy sources will also add significantly to a prolonged era of the energy resource abundance. Critical to this will be the development of new technologies and facilities to store electricity generated from renewable sources such as the plant currently being created in Ireland and extra long-life batteries.
 
So, rather than leading the way, it would appear that OPEC is waving the white flag. Its policy over the last two years to bring the US shale industry to its knees has failed, and although the pockets of members such as Saudi Arabia may be deep, they are not bottomless, as recent unpopular austerity measures have proved. Income is urgently needed to fund domestic development programmes and an attempt to increase the oil price is the easy solution.
 
At the recent Oil and Money conference in London, it was suggested that rather than a rapid return to the days of US$120 per barrel oil enjoyed before the summer of 2014, a more modest price in the range of US$50 to US$60 per barrel within a year’s time was more likely. Anything more extreme could spark a drilling frenzy among the shale producers that could bring the price crashing down again.
 
This, of course, is not a particularly encouraging forecast for the North Sea oil industry, where a price of $US60 per barrel offers limited incentive for new field development; but our industry is in transition. Industry body Oil & Gas UK recently suggested operating costs would fall to US$16 per barrel in our waters this year, down almost US$6 per barrel on this time last year.
 
The shale industry has given us many pointers on how to not only survive but thrive in a low price environment and we have to do the same: collaborate, standardise, adopt new technologies and maximise output. If we don’t, to coin the Rollers’ biggest hit, it could be ‘Bye Bye Baby’ for North Sea oil. 

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