The oil market narrative…

Robert Schiller gave this lecture earlier on the year on the power of the narrative in economics and it concerns:

 the epidemiology of narratives relevant to economic fluctuations. The human brain has always been highly tuned towards narratives, whether factual or not, to justify ongoing actions, even such basic actions as spending and investing. Stories motivate and connect activities to deeply felt values and needs. Narratives “go viral” and spread far, even worldwide, with economic impact.

It’s wide ranging and I would recommend all 57 pages. Schiller argues that epidemological models from biology maybe a good basis for integrating narratives into economics. Evolutionary economics has been hugely influenced by biologicals models of change and there is no reason to believe behavioural economics cannot be just as influenced.

Given the action in the oil market I regard this as a good a theory of market price developments as any other. Deep down clearly the market fundamentals count i.e. the basic where demand will meet supply. But up until a few weeks ago the dominant logic in the oil industry was clearly just how rapid price rises would be, and yet how quickly this has changed in the past week after the IEA claimed we were underinvesting massively.

Reuters published an interesting story last week about how bullish oil companies were, indeed the market narrative was summed up by this analyst:

“The investor mindset is switching to growth again,” said Anish Kapadia, analyst at investment bank Tudor, Pickering, Holt& Co.

“Oil prices are above $50 a barrel, companies are generating cash and are starting to talk about growth again, we are at that point of the cycle.”

But they also dumped in this casual data point:

Even as prices LCOc1CLc1 hold near $50 per barrel, the firms – Royal Dutch Shell Plc (RDSa.L), Exxon Mobil Corp (XOM.N), Chevron Corp (CVX.N), BP Plc (BP.L), Total SA (TOTF.PA), Statoil ASA (STL.OL) and Eni SpA (ENI.MI) – plan to grow output by a combined 15 percent in the next five years…

The seven companies will add almost 3 million barrels per day to their combined output in the next five years effectively generating production the size of another major like Chevron. [Emphasis added].

The FT this morning had an article about Leonardo Maugeir, who used to head strategy for ENI,  and his views who has written this article:

In January, my similar field-by-field analysis indicated that world oil production capacity and actual production were still growing—while prospects for demand growth were not sufficiently high to absorb the excess supply. In particular, actual oil production (which includes crude oil and other liquids such as condensates, NGLs, and more according to the standard definition used by most statistics) was almost 99.5 million barrels per day (mbd)—leaving a voluntary and involuntary spare capacity (the result of local civil wars and other geopolitical factors) of more than 4 mbd.

Frankly any sane person is going to be bored-to-death by potential supply/demand imbalances of 1-2m barrels a day (or 4m or whatever, life is too short), and the models underpinning these are so complicated they can only ever be directionally correct, but the core point here is how they are shaping the narrative. The narrative seems to have turned to the downside, to the potential of shale as a marginal production source of choice, and the potential for oversupply in the industry. Too many people in the industry still just refer to “when the next boom comes”, but having predicted 9 of the last 0 house price crashes in New Zealand I realise that such predictions offer little value. Is there really going to be another boom? What will it look like? And when really will it come?

But the value, and the interest, in oil, seems to be the euphoric highs and lows (and the investment returns that mimic this), driven partly by the narrative.  I wonder if it’s a function of the sheer scale of the capital investments that have previously been required to make a meaningful increase in production? I wonder if shale won’t modify this somewhat?

I’m a long run guy. Maybe in the long-term shale, with much smaller capital commitments per well, will make the oil industry less cyclical as marginal production can be more efficiently brought in and out of use? Everything in life is relative (in an economic sense). Modern economic growth is usually dated from c. 1500 (which the Great Man ascribed to the price revolution), maybe the importance of oil from the beginning of the 19th century was just a blip in the economic cycle of the post 1890 long globalisation age, in which case we have just been through a Cambrian Explosion of innovation and now the oil extraction industry settles down to maturity with less price volatility and more constant productivity improvements one would expect from a more mature industry? Maybe shale is the productivity revolution that matches supply and demand after a 40 year lag when oil prices really took off in real terms? Productivity improvements are not linear but erratic. The dominant narrative until just a few years ago was that “all the easy oil is gone”, now that just isn’t true again.

oilprice1869.gif

Maybe I am actually a random walk guy? As always I back technology and productivity improvements over long-run resource scarcity and supply issues given relatively free markets. I therefore err on the side of lower oil prices for some time, especially given oversupply in the servive sector.

 

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