Fundamental change or short-term shock?

The most popular letter in the FT today compared the review of Crude Volatility by Robert McNally (a Bush adviser) by the FT Energy Correspondent, Anjli Raval, to The Price of Oil by Roberto F Aguilera and Marian Radetzki. Basically, McNally argues we are in for a wild ride on prices and supply while Aguilera and Radetzki come in for shale and technology and permanently low prices. The writer agrees with fracking our way to salvation and permanently lower prices.

I read the read the review and admit McNally lost me with this:

But industry attempts to tame the market in the past have either had minimal success or been defied. The arrival of US shale in recent years has rendered Opec unwilling or unable to control the market, McNally says. With Opec’s power ebbing, “we are going to be unpleasantly surprised by chronically unstable oil prices”.

Come again? Normally getting rid of a cartel stabilises prices and lets market forces determine supply and demand? I couldn’t be bothered to read the book based on the review because it all sounded a bit contrived: you cannot control a cartel with that many players (as Opec is finding out), and as the famous Hunt Brothers (oil men to the core) discovered you can’t control a complex market like silver (or oil I’m betting on).

I haven’t read Aguilera and Radetzki’s book either, but they have a lot of stuff on the web that makes their view clear (at Vox and Scientific American). As they say here:

Using simple and reasonable methodologies, we estimate that the shale revolution outside the US will yield an additional 20 million barrels per day (mbd) by 2035 – nearly equal to the rise in global oil production over the past 20 years.

And look how much the cost curve for shale has changed since they published this in 2016:

Cam Rystad

The cynic in me naturally errs to favour technology over political market determinism in as much as I get concerned about these things. I guess that makes me long shale in my views. I still think offshore will be a major part of the energy supply mix (as the above chart makes clear), but perhaps less a part of the overall portfolio than we hoped in the near distant past.

I’m a believer… just in something different…

A good FT article here about how oil and gas discoveries have recently fallen to their lowest levels ever. I’m with Spencer Dale and the shale crowd… it’s the marginal production expansion reserve of choice… but I’m also with offshore… I just think the next boom will be somewhat different and probably less of a boom.

However I also think the focus on Reserve Replacement Ratio (RRR) will also diminish somewhat and E&P companies will be more focused on other issues beyond discovery levels. RRR is a good concept when you are reaching the frontier of oil production, and certainly no one cared about it more than Exxon Mobil, but its a measure of interest really only when the entry and CAPEX costs of increased production are so high. Its not even a measure of exploration efficiency because companies that cut back offshore CAPEX clearly are not seeking to replace reserves 100%. RRR is a relic of bygone era when  you couldn’t drop a few billion and buy some decent shale acreage or a small Swedish start-up didn’t strike it big in the Barents.

Large E&P companies have shown in the downturn that they are committed to constant dividend payments, regardless of underlying cash flow generation where possible, and I think it likely reserves will go the same way: some years there will be a bumper increase and other years a decrease, the trend and stability more than the absolute limit will become important.

I mention this in the context of offshore because not only has shale changed the production economics (as I have discussed before) but also because it is likely to make a recovery from this offshore exploration trough slower than people would like. I do believe in offshore long-term… just the new offshore economics not the old.