A brave new world…

“One believes things because one has been conditioned to believe them.”
Aldous Huxley, Brave New World

Yet a rebound in prices, ineluctable as it may be, will not turn back the clock on the oil market. Nor will it mark a return to the status quo ante. The market that emerges from the current process of rebalancing will differ from the one that preceded it. The idea of a pendulum swing in oil markets is unexceptional; such swings have occurred in previous episodes of price correction. But this swing is different. When the dust settles, the market will have shifted, perhaps beyond recognition. The process of adjustment and restructuring ushered in by the price collapse marks the beginning of a new era in the history of oil and energy markets that will present both opportunities and daunting challenges for the industry.

What makes the current selloff and coming recovery different from previous market cycles is the advent of U.S. shale oil. The shale revolution has transformed oil market dynamics. It triggered the oil price collapse. It is now shaping the course of the recovery. It will eventually define the features of the energy landscape that will in due course emerge from the downturn. [Emphasis added].

January 19, 2016, Congressional Testimony of Antoine Halff, Senior Research Scholar and Director of the Global Oil Market Program, Center on Global Energy Policy, Columbia University School of International and Public Affairs

Before the Committee on Energy and Natural Resources, United States Senate

I came across the above article today. It is remarkably prescient about the changes that would occur in 2016/17, although far too cautious about the ability of the US to create another production basin on the scale of Iran in the Permian. Halff talks of a “two speed industry”:

Last but not least, the advent of the shale oil industry has been challenging the very business model of the oil industry. Oil companies have traditionally been large, deep-pocketed and professionally conservative, and have usually operated under a price umbrella of one kind or another: Rockefeller’s Standard Oil, the Seven Sisters, OPEC. Shale oil companies – small, nimble, highly leveraged, intensely adaptable – break that mold. Whereas conventional oil production requires large upfront investment and lead times measured in years if not decades, the shale business cycle is shorter: upfront shale costs are relatively low; decline rates are steep; lead times and payback times are measured in months rather than years.

Which is the Spencer Dale argument I use here often. The economists appear to have this seismic shift well understood. There is a great article by John Kemp on Reuters (where the featured graph came from) noting:

Benchmark Brent prices have already risen by more than $45 per barrel or 170 percent from their cyclical trough in early 2016.

Front-month futures prices, at almost $75 per barrel, are now trading close to the inflation-adjusted average for the last price cycle, which started in 1998 and finished in 2016.

So far this year, futures prices have averaged nearly $68 per barrel, which is well above the post-1973 real average price of $50-$55.

Futures prices have shifted from a big contango during the slump into an increasingly wide backwardation since the middle of 2017, which is consistent with a shift from over-supply to under-supply.

Both commentators above see the rising price as risking nothing more than a boom in shale spending. And in a way we are in a mini-boom. When the price of a commodity rises 170% in 24 months it is normally viewed as a recovery. The spot price of oil might go higher…  For a supply chain long on capacity and supply it just doesn’t feel like it…

In that vein Shell released their Q1 results yesterday. What everyone in offshore was hoping the Shell CEO would say was this:

“Shell released excellent numbers with a rising oil price today. To that end I have instructed the upstream department to immediately commission as many offshore projects as possible. Rigs, jack-ups, boats, there will not be enough by the time I have finished signing purchase orders for major projects. If you thought 2013 was busy wait until the Shell Board has finished approving projects”…

Of course what the CEO actually said was this:

“We have a strong financial framework. Our commitment to capital discipline is unchanged, we are making good progress with our $30 billion divestment programme and our outlook for free cash flow – which covered our cash dividend and interest this quarter and over the last year – is consistent with our intent to buy back at least $25 billion of our shares over the period 2018-2020.”

As I said yesterday this is a different world from 2013. Shell shares actually dropped on the news despite the fact they are making higher profits than on $100 oil. And the hangover from the 2014 downturn is still there for E&P companies because Shell paid dividends with shares recently to cut the cash cost, the commitment to reduce the number of shares on issue is just the slowburn effect of the downturn that reduces cash available for projects.

And Shell make it very clear that for the next three years if Deepwater spending comes in at the low end of forecasts, and Shale and New energies come it at the high end, then both will be worth ~$5bn (only $1bn seperate them at the top end):

Shell Q 1 2018 CAPEX

Shell doesn’t appear to be markedly different from any other large E&P company: Total had a very similar theme yesterday as well. Secular change brings a brave new world…


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