For the next three posts, we’re going to take a deep look into the future on three commodities important to us here in GR&A: Oil, Natural Gas and Electric Power. The recipe for each section will be one part current events, one part analysis and a pinch of the ever important speculation (it’s kinda like salt, but for forecasters. Add it to taste).
In the crude section, we will discuss OPEC’s market-share capture strategy. In the gas section, we will touch on how the link between oil and gas will strengthen. In the power section, we will highlight a specific regulatory development in California that will shed some light on the future of the industry.
CRUDE OIL – How Long is OPEC’s Game?
You have probably seen charts like these before, which illustrate the dramatic increase energy demand expected from the developing world. You may also notice that total energy demand projections for China tops out around 2030 while demand from the rest of the Non – OECD countries continue to grow through the charted period. So what more can you make of this chart, and what does this have to do with oil specifically?
- While the general trend of energy use in raw BTUs is a reasonable assumption because developing economies will increase the amount of stuff they make and the density of energy consumption, the precise source of that growth is mostly indeterminate. Telative cost and convenience often determines which sources of energy are used (e.g. coal is cheap but not practical to run an internal combustion engine). In order to ensure as many new markets as possible adopt oil products for their energy source of choice, continued low prices will be needed to spur this development. As a perfect example, Brazilian sugar-based biofuel is competing with oil for share in the transportation sector.
- As the graph below illustrates, Saudi Arabia alone has a unique ability to contort the market. These changes to production are not price reactions in the perfect competition sense, where wells operating on the margin cease production due to price declines and reenter service from price increases – these production adjustments are evidence of the Kingdom’s ability and desire to manage global supply.
- You may have seen figures that require oil prices to be $80 or $90 or even higher for OPEC countries to produce – those are ‘governement budget’ figures (we all know a gov’t budget doesn’t need to be balanced). Actual production breakevens are much lower for most OPEC countries, generally below $30/bbl.
I believe OPEC’s strategy to cease balancing the market at $100/bbl is extremely far-sighted. Member countries with state-run oil companies often have the ability to act differently than profit-seeking companies and can look to maximize profits in the long-run (the Keynesian “we’re all dead” long run). OPEC is looking to maintain supplying 1/3 of the oil market, but the cartel isn’t just competing as an oil producer with US shale and Russia. Over the next 25 years, OPEC oil is competing with biofuels, solar panels, low-cost batteries and plain old energy efficiency – OPEC wants as much of those 200 Quadrillion BTUs of new energy demand to come from oil as possible.
And in the short term, that certainly means prices are going to fall even more, likely testing lows below the true cost of OPEC production.