Here's a scary thought: Wood Mackenzie estimates that the oil markets will be undersupplied by 4.5 million b/d by 2035 if capex spending doesn't improve.
In 2015, only 2.9 billion barrels of liquids was discovered. That really brings up the following question: How much will oil cost in the future?
The chart above highlights what the capex spending will be in the next four years. As you might have noticed, a bulk of 2020's exploration budget is on a discretionary basis. If oil prices remain volatile until then, this segment of the exploration budget would be cut. This should then lead to the inevitable question: What happens if the world doesn't have enough supplies?
In 2008, the peak oil theory took hold and market participants drove the price of oil to $140 per barrel. In 2016, the "abundant" oil theory took hold and market participants drove the price of oil to $26. In both situations, the sentiment was over-exaggerated and led to an inevitable fall and rise in the price of oil. Peak oil was never about "running out of oil," just like "abundant oil" isn't about having too much oil. The concept for both needs to be taken into consideration, and a sensible logic needs to be applied to understand both arguments clearly.
For peak oil, the theory is based on the world running out of "cheap oil." As conventional production continues to decline, the rise of shale oil production is a testament to how "expensive oil" is replacing the cheap oil.
The "abundant oil" theory is somehow based on the premise that 5% of the world's global oil production (shale production) can keep the world supplied with oil because it's "short-term" cycled. The same level of skepticism needs to be applied here. Shale production has kept U.S. production relatively flat in 2015, because shale companies were drilling sweet spots only while using longer laterals and more sand. Both of these techniques increase the initial production rate, but are subject to a higher decline rate and lower EUR over the lifetime of the well. You can say that the companies were greedy in the short run and stupid in the long run. This decline is now starting to show in the weekly oil inventory reports, and it will only get worse.
EIA continues to revise down its 2016 U.S. production estimates, and we believe it is more likely for the U.S. to have 8-8.2 million b/d of production by year-end.
Wrapping It Up
While most people remain skeptical of the recent rally in oil (NYSEARCA:USO), we believe the focus should be longer term. If the current capex budgets continue there will be a dramatic shortfall in supplies, and this could wreak havoc on global economic growth.
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