Crude Oil Demand and the Quick Recovery Hoax

Major oil companies around the world announced their Q2 earnings results last week and a litany of losses they were. Royal Dutch Shell (RDS.A) posted a 67% loss; ExxonMobil (XOM) 66%, PetroCanada (PCZ) 95%, BP 53%, Connoco Phillips (COP) 76% and Repsol (REP) YPF 62%. The causative factor as cited was weak demand which depressed prices. For ExxonMobil it was the third consecutive quarter of y-o-y earnings decline. Shell has embarked on an extensive cost-cutting program which has seen the retrenchment of 150 of its top level management cadre, in order to stem a rising debt profile.

While the oil majors were sustaining earnings losses, crude oil prices doubled betwen early Q1 and end Q2, and that, without any market fundamental support: the market was massively over-supplied, demand was (and is still) weak and the economic recession did not show credible signs of effective recovery. During the oil price shock of 2008, oil prices were rising steeply while the market was well-supplied and that has been in the main, the case with recent oil price surges.

These conditions do not admit a quick demand recovery, a point conceded by the Chief Executive Officer of Royal Dutch Shell in his Q2 statement. The much-bandied projections of quick demand recovery and even an impending oil price shock now seem fatuous.

My positions do seem strengthened: in a recent post l argued that even an increase in energy demand occasioned by a strong economic rebound will not likely translate to a commensurate increase in oil demand and that recovery will most likely be very slow. l also proffered that in the unlikely event of an oil price shock following a global economic rebound, such shock is unlikely to bear any market fundamental support.

Disclosure:None

Comments

[A Barrel Full:]

I would like to second epeon. We need to run just to stay still in terms of production.

Aug 03 08:51 AM

[Ferdinand E...:]

The key thing where the oil price is concerned is the policy of OPEC. I have said enough about this in my papers and energy economics textbook so that everyone who reads English should be able to get the message. Of course many of these persons don't get it, but that is their problem.

Aug 03 09:01 AM

[skrummydummy:]

As others point out, the oil majors did show profits, not losses. But what rankles me most is the year over year comparisons that some analysts keep highlighting. Such comparisons are very misleading and are akin to yellow journalism--Oh my, "down more than 50% from last year"!!! Give me a break. Let's take a longer range view.

Skrummy

Aug 03 09:34 AM

[The Greates...:]

I too tire of the headlines reading about how all the major oil companies (5 total of the big boys) are just losing their hat, (ass), and fixtures. Please, the numbers today if based a year ago show a drop in revenue, THAT IS ALL they represent. The oil industry as a whole has reaped $476 Billion in net profit over the last 6 years. Put in the numbers from 2008 and it is adding another $136 million to the total. They make a dandy profit at $65 a barrel and up, and demand is down real low today, case in point the huge rising surplus in crude oil and gas held in storage today. I believe that the current price is being supported on the hearings in all the worlds government concerning speculation in the market and the future (if any) regulations coming from these hearings.

Aug 03 09:52 AM

[Dennis U. A...:]

This concept of a global future doomed to oil price shocks and oil demand crunches has been much-bandied:

In a previous post (Oil Price Shocks and Market Fundamentals) l clearly outlined why an oil price shock with fundamental support is most unlikely, save for extenuating circumstances (war or the equivalent, etc).
In another (Expect Slow Growth of Crude Oil Demand), l also explained why the projected reduction in developed economies' demand for oil will most likely not be counterbalanced by that of developing economies such as Brazil and China.
It is not worth reharshing these here but it must be said however that many mistake a projected increase in energy demand for a commensurate increase in demand for oil; that is certainly not the case.

As for the "losses", maybe we are just trying to put a sweetener on an otherwise unsavory corporate item. A 95% reduction in earnings is certainly a massive loss even if (technically) a profit is made.

Aug 03 10:16 AM

[Michael Fit...:]

a "95% loss" is overstating reality. these are quarterly earnings numbers, and while certainly down significantly over last year, do you actually think these lower earnings reports will be sustained long into the future? look at the price of oil alone - it went down to around $40 and now is at $70 and the worldwide economic recovery is in its infancy at best. i will grant you that natural gas is in a fundamental slump due to abundant production, but after a winter or two of cut production, this too will bounce back. the US is 60-70% dependent on foreign oil and completely dependent on gasoline for transportation (despite perceptions of obama's "energy policy" changes). how do these facts not setup the near future for another oil price spike based on fundamentals (and a weakening US currency) ? some folks are acting like $70/barrel oil is "cheap". remember, only 5 years ago oil was in the $30. that is, today after falling 50% from the highs, it is still up over 100% in the last 5 years. this is why energy stocks are up over 10% annually over the last 10 years while the S&P500 is flat (or even negative when the US dollar weakness and inflation are taken into account). it doesn't take a genius to put 2n2 together here...

Aug 03 10:38 AM

[The Greates...:]

Americans everywhere are also looking at huge losses this year, their income has been cut by 450,000 jobs a month since last year. They are seeing their disposable spending cut to $0, and yet gas and diesel cost are still on the rise, for the lucky few who still are holding a working FT job. So, it is hard to swallow that the oil industry is basing their record losses on the numbers from 2008, but they are clearly still making a profit in 2009.

Aug 03 10:39 AM

[retired358:]

Dennis: For those of us who have been in the industry for decades, the facts do not appear to support the thesis that we cannot see a crude oil price spike in the future.

As others have pointed out, just to maintain current production levels requires that the industry find and produce an additional 4-5% of current production each and every year - just to replace natural field declines. If one looks at the data on new finds, one will see that the average size of fields discovered is decreasing and the production cost is increasing (harder to find and necessary to go deeper and/or colder). And, ultimately, the cost of crude oil will be the cost of the most expensive bbl produced to meet demand.

With respect to demand, it is difficult to assume that the people in India and China will not want to increase their standard of living (which requires energy). Even if their energy usage increases to just 1/4 that of Japan or Europe (over time) times the differences in population, demand will increase significantly.

I fully support unconventionals and renewables - they will be needed - but they cannot be developed fast enough or in sufficient quantities over the next decade to meet all of the increased demand. And, to the degree they are developed, their cost is much greater than that of producing crude oil and their price will then set the cost of energy.

So, I am placing my investments in crude oil over the next decade.

Aug 03 10:55 AM

[retired358:]

And the word "Hoax" used in the title of your article is used because:

1) You really believe it? You have not convinced me with your "factual support"

2) You are trying to incite others against the industry?

3) You are trying to sell your services?

Aug 03 11:02 AM

[Gravity404:]

Poor article. Perhaps you should put down your thesaurus and do your DD. Instead of $40 BILLION in PROFITS! XOM is now earning a measly $39 Billion with an 11 PE. It was earning growth that declined.

And maybe oil hovering around $70 is telling you something…it’s going to require an ever large premium. With 3 billion people moving forward, it’s going to require more and more energy... exponentially – oil, Nat Gas, wind, solar, bio, and, yes, algae. (In 5 years algae will be huge and XOM will be right there.)

This has been a golden opportunity to BUY -- XOM, COP, CVX, RD, PBR, APA, APC, DVN, MRO, KBR, MDR, ABB, FLR, NOV, BHI, SLB, HAL…etc…diversify across integrated, independents, EPC, Refinery, Large cap, small cap, mid cap, emerging markets, tech, China, Brazil, Russia

Aug 03 11:06 AM

[Dennis U. A...:]

The issue of oil evokes so much passion and some have even gone to war over it. Opinions about are often polarized and implacably so. But l have to correct someone who misquoted me and just leave it there:

An oil price spike does not necessarily entail a market fundamental support. As l have noted, during the 2008 oil price shock, prices were rising steeply while the market was well supplied. The recent price spikes were in spite of massive supply overhang. l did not say an oil price shock will never occur, l only said that if one does occur, it will most likely (save for extenuating circumstances) show no fundamental support:

Rebound from the current economic downturn is expected to be slow and drawn-out. The current efficiency program of President Obama is expected to lower oil demand by about 1.8 billion barrels (that's about the equivalent of the total US domestic production for 2008) within 7 years. Even half that is massive. Brazil and Saudi Arabia have made some of the largest oil discoveries in recent history. Even China's seemingly aggressive "energy grab" is actually a measure to address near-term needs while rapidly developing elaborate alternatives for longer-term requirements.

All said then, let time tell.

Aug 03 11:31 AM

[Alan von Al...:]

Good comments from knowledgeable people. My two cents, I'll echo what Dennis said about Shell cutting staff -- all contractors and some early retiree middle managers. They're cutting exploration, keeping the bean counters, lawyers, brokers and midstream engineers.

Aug 03 11:34 AM

[Eminencegrisse:]

So what's the real "hoax"? Perhaps, it's that conventional discussions of oil supply conditions focus on inventory levels, which represent perhaps 3% of the true supply story.

Conventional thinking is comfortable basing it's pricing discovery on such a small subset of information because it believes oil reserve life depletion will always be outscaled by new discoveries.

So I ask you, where's the hoax?

Aug 03 12:57 PM

[Tony Daltorio:]

You are making the same mistake that many investors - you are fluffing off the growth in energy demand from the emerging world. It is that growth which is key to the future price oil, not energy demand in the US.

Aug 03 02:24 PM

[Barry Hansen:]

I would like to second Mr. Michael Fit's opinion. There is no "litany of losses" going on in the oil patch. It is merely a decline in earnings usual to a cyclical industry. Mr. Atunya, a decline in earnings does not mean losses.
Barry Hansen

Aug 03 10:12 PM

[The Greates...:]

I have to reiterate the oil industry is doing just fine at $65 a barrel, as for the rest of the world, they are still digging out of the hole made by the 2008 energy spike.
Oil will be on life support by Dec 09, $35-$40 a barrel, or the world will never recover.

Aug 03 10:41 PM

[retired358:]

The Gretes...:

I am not sure that the recession/depression, or whatever the world is digging out of, was caused by the 2008 energy spike. The energy spike reduced demand and did not help the situation but the "hole" was caused by the subprime mortgages and "speculation" in the related insurance swaps/derivatives.

Aug 03 11:18 PM

[Old Trader:]

The fact that the emerging markets consumed more oil than the developed countries for the first time EVER would fly in the face of the author's assertion that growth in developing countries will be not be sufficient to offset the developed countries declining demand. If the recession/depression gets worse, perhaps that would hold for a quarter, or two....over a span of 3-5 years? No way, Jose.

Aug 04 12:40 AM

[Toffe:]

I would suggest the authors point of view is OECD myopic or even worse, US centered. This ignores the much larger global picture. I would suggest to back statements up by facts (on both sides), otherwise it becomes two sets of ignorant fools shouting at each other as seen above. Here is one authority on the demand/supply balance: www.iea.org/textbase/p...

With global GDP growth revisions constantly being down, the demand side of the crude price equation is weighted down, however the supply will not keep up even with the lower growth estimates in the medium to long erm. Economics isn't a religion, where believing is enough. It is a social science, which calls for backing up statements with researched facts.

Big oil earnings have dropped like stones from unprecedented levels in 2007/8, largely because they have got too comfortable, lazy and inefficient. With no prospect of oil at $20/bbl for a sustained period ever again, large companies have acquired bloated management, "R&D" and inefficient supply chains etc. Golden opportunity medium to long term for renewables and start-up oil producers.

Aug 04 04:36 AM

[retired358:]

The major issue with renewables (and unconventionals) is that crude prices are unstable and no financially responsible company can risk the major capital costs with this level of volatility.

Those renewables (wind and ethanol) being expanded are due to the result of gov. subsidies - and the unintended consequences are often ignored. Ethanol is not very efficient (from corn) and it is socially and morally wrong to starve people elsewhere to make fuel from food. Wind is installed (that is where the subsidy is) but the cost of maintaining is sometimes greater than the elect. value generated (notice how many older fields have many non-working turbines).

Aug 04 01:04 PM