Welcome to the shortage edition of Oil Markets Daily!
(Note: This article was first published to HFI Research subscribers on 1-20-18. If you are interested, see here for more info about our flagship weekly report.)
Over the weekend, one of our favorite tweeter following, Anas Alhajji, tweeted that:
“The message that the IEA is sending to major oil producers: do not invest in upstream, oil from the US and Canada is going to flood the market. Now imagine how oil producers are going to react. Investment will decline while oil demand will continue to grow.”
Surprisingly, IEA’s head of oil division, Neil Atkinson, tweeted back saying:
Now, we have written in the past that IEA has warned of a potential supply cliff coming. Here was the “blog post” IEA published on March 6, 2017 titled, “Global oil supply to lag demand after 2020 unless new investments are approved soon.”
In that blog post, IEA goes on to say that:
We highlighted the portion that was worth noting. IEA’s Executive Director, Dr. Fatih Birol, says that there will be a “new period of price volatility looms on the horizon.” He does not specifically say “higher oil prices” but “price volatility.”
Excuse me? Is that the same thing?
In research writing, this kind of forecast is called “speaking from both sides of your mouth.” As a publication, you can easily hedge yourself of bad forecasts by using words like, “price volatility”, and “potential”. In essence, you take zero forecasting risks because you do not specify if prices go up or down, or whether the world will really be short on oil supplies.
This is what IEA is doing right now. Instead of being the energy agency that was created to help the world navigate away from a supply shock or vis-à-vis price spike, the energy agency is playing the game of politics by giving flimsy supply outlooks and double hedging their own research.
What does this mean for global oil supplies?
The world’s biggest oil producers are taking IEA’s words into the heart. Just take a look at the capital expenditure changes slated for 2018:
Despite the global oil benchmark, Brent, climbing close to $70/bbl, we are seeing a capex reduction in major oil producers. Why? Because instead of the IEA mentioning that a supply shortage will lead to a price spike, the energy agency is complacent and saying that US shale oil “could grow” at a higher price point.
For the oil majors, they are looking at this uncertain outlook in oil prices and saying to themselves, “Why don’t we just invest in US shale versus multi-year conventional projects? We don’t know what demand is going to look like, and we have to pay dividends. Let’s take less risk.” And you can see this reflected in the latest upstream capex.
This type of misinformation should lead readers to think that an inevitable supply shortage is coming. We say that because there are two major data points that are screaming out a shortage is on the horizon.
First, global conventional production decline rates are at the highest they’ve ever been due to lack of upstream capex.
Source: Rystad Energy
To give you an idea, out of the ~97 million b/d or so of global oil supplies, ~10 million b/d comes from unconventional oil production. Let’s be safe and say that ~80 million b/d are from conventional sources. A decline rate of ~7% (average b/w onshore and offshore) on 80 million b/d equals 5.6 million b/d the world needs to replace every year to just stay flat, or to put it in other words, we need TWO new Permian basins every year to just replace the decline rate.
Now how do we know this is starting to really impact global supplies? We see this in month-after-month of production data disappointments coming from Norway, Mexico, Brazil, China, Venezuela, Colombia and other major oil producers. The 100k b/d here and there are starting to add-up, and if IEA doesn’t come out pounding its fists on the table screaming for a potential price hike stemming from a supply shortage, we are going to see the inevitable outcome play out, or as Pain Capital says, time is on our side.
Second, the most distressing data point out in 2017 was that global conventional discoveries hit the lowest level since the 1940s.
Source: Rystad Energy
If global oil demand was peaking and trending down, then we can look at the first and second data point and say, “we are fine.” But that’s clearly not the case when global oil demand is expected to surpass 100 million b/d this year!
Is the world really ready for this oil supply shortage on the horizon?
To make matters worse, IEA is not meant to give price forecasts, but IEA’s Neil Atkinson came out saying in Feb 2017 that:
"I think 63, 65 (dollars a barrel for Brent) I think you might be a little bit ambitious there because the OPEC producers have got this basic issue, they don't want the price to go too low clearly, because their economies wouldn't stand it," Neil Atkinson, head of the oil industry and markets division, at the IEA told CNBC Friday.
Um… We thought you said you are encouraging upstream capex spending? By the sound of that interview, why would anyone invest in more production if oil prices can’t climb?
IEA’s short-term thinking, complacent analysis, and political motivations will lead the world right into an oil supply shortage. By now, there are practically no scenarios that take us away from an impending global supply shortage by 2020. If the synchronized global GDP continues, it signals ever increasing higher oil demand, and the shortage may come sooner than everyone thinks is possible.
So, what’s going on? IEA is complacent, and its two-sided research will lead the world into an oil price spike.
Buckle up, it’s going to get ugly.
HFI Research Premium
For those of you who have found our articles insightful, interesting and different, we think you should sign up for HFI Research. Our incentive is aligned with our readers as we put our money where our mouth is, and our contrarian analytical framework was what set us apart when we made the $65/bbl Brent call in June 2017 and $60/bbl WTI call for the end of 2017. For more information about our service, please click here. We look forward to seeing you join the HFI Research community.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.