Another IEA supply warning…

Prediction is very difficult, especially about the future.

Neils Bohr

The International Energy Agency once again warned today that we face an oil supply crunch if investment levels remain at current levels and their “forecast” for increased energy demand remains accurate:

There are still not enough signs of investment beginning to return, and that raises the risk of tightening of the market in the next five years and a risk to the stability of oil prices,” Neil Atkinson, head of the IEA’s oil markets and industry division, said at a conference in Bahrain. “There is at least a possibility of going back to the situation we had 10 years ago where oil prices were very, very high at a time when demand was growing.”

Atkinson warned that the market’s spare capacity—largely concentrated in Saudi Arabia—will dwindle as demand keeps rising at a time when supply remains stagnant. The market will tighten and OPEC will have to abandon its production limits in order to satisfy demand. After that, rising consumption could whittle away at the latent surplus capacity. At that point, the market will hit a supply crunch, which would likely result in higher volatility and higher prices.

As an aside here is a list of OPEC member states. Does anyone really believe they can hold a production limiting agreement indefinitely?

If correct it is good news for offshore with a likely investment boom coming… but not until the 2020’s apparently. For oil companies that are cash flow positive even with high debt that might seem manageable, if you have vessels in lay-up or underutilised it is going to look like a long way off.

Like all forecasts understanding the context they come from is as important as the forecast itself. It is fair to say there is some fairly pointed criticism about the accuracy of these forecasts, FT Alphaville recently published this (guest) piece that noted this about IEA data:

  1. They are not forecasts, they are scenarios and named accordingly.
  2. The IEA publishes more than one scenario. Each one represents a different assumption about *policy* [again, the clue is in the title: Current Policies Scenario, New Policy Scenario, and 450 Scenario].
  3. Almost no-one, anywhere, ever seems to pay any attention to either 1) or 2). It’s very common to see “forecasts” or “projections” attributed to the IEA without even specifying *which* IEA scenario they’re talking about.
  4. The IEA’s scenarios have been consistently terrible at illustrating how well clean energy, might play out in almost any scenario. And terrible in the same way.

The problem is that in order to understand all this you have to buy (and read) the IEA report not just read the press releases and newsfeed stories commenting on the press releases. Javier Blas, ex-FT and now Chief Energy Reporter at Bloomberg, had a spat with the IEA in may this year after a Dutch academic showed how far out of line the IEA had been with solar predictions (since 2003). This led the IEA comment :

This misrepresents point of WEO (World Energy Outlook) scenarios. They don’t forecast future, but provide yearly picture of what will happen if nothing changes

Which is sort of like useless for such long-term scenarios unless nothing in the world changes (file that under unlikely) which is Blas’ point (I think). This does have the advantage of clarity though so you know exactly what the scenarios are based on. As if to underline it Blas published this today:

Evolution of Wind.png

It’s all about productivity… At the margin all energy products have a degree of substitutability and the renewable sources seem to have that advantage at the moment as they grow in scale.

Bloomberg had an excellent article earlier in the year highlighting how demand for oil could vary under different scenarios:

A Radically Different Future

And is if to highlight how much things can change we learnt today that shale production is apparently slowing but building up “Drilled but UnCompleted” inventory:

the buildup of DUCs is also bearish since it creates latent supply. Because the incremental cash cost to start pumping crude is low for a DUC, the payback period for an oil company is only a year or so. Even for wells not drilled, analysts at Citigroup estimate the break-even cost to drill and complete a well is just $29 a barrel on a production-weighted basis for the drillers they cover once the costs of acreage and sunk capital costs are excluded for the companies they cover.

No one can know the future so the most important thing any forecaster can do is simply make their assumptions (and preferably limitations) clear. The IEA forecasts need to be seen as relatively bullish from an organisation that makes a living from advocating policies that increase investment in traditional fossil fuels. Therefore whether its errors are cognitive or merely emotional biases the answer is likely to be somewhere between the two: but the word of God from an impartial agency with the wisdom of Solomon they are not.

For the offshore supply chain I do actually think we have hit the nadir, the point of this isn’t to say it can’t get any worse, and in maintenance spend terms things are likely to get better soon. But a boom case for the supply chain is hard to make because the ramp-up period will now be substantial as people and assets leave the industry and large E&P companies focus on other areas, and I don’t believe the 2013 days will ever return: nor should they the offshore industry can be more efficient than that. The one thing I do know is that if I was an offshore contractor I’d make sure I had a renewables strategy to go with my oil and gas one.

Productivity in the long run…

I go on about it a lot but productivity is the core of economic growth and undertsanding its importance is crucial to having a reasonable chance of understanding how an industry may evolve. Brad De Long makes this clear when discussing the iPhone X;

Consider the 256 GB memory iPhone X: Implemented in vacuum tubes in 1957, the transistors in an iPhoneX alone would have:

  • cost 150 trillion of today’s dollars: one and a half times today’s global annual product

  • taken up a hundred-story square building 300 meters high, and 3 kilometers long and wide

  • drawn 150 terawatts of power—30 times the world’s current generating capacity

Renewable also energy seems to be in a marked phase of marked productivity improvement:

better_energy_01.jpg

I am not predicting the end of oil already: it is simply too efficient on an output basis. but in the long run everything is a productivity game, the supply curve in oil is just a very long run curve that requires technology to fundamentally change it. And for offshore it isn’t doing that much at the moment. The risk here is that large E&P companies reduce their focus on CapEx for offshore, which becomes self-fulfilling because it prompts infrastructure investments that make renewables even more efficient. Most commentators believe this productivity surge has a long way to go with maybe a 20-30% further cost reduction by 2030.

And big institutions have the investment narrative that says this is hot with Blackrock Infratsructure (who admittedly have their own agenda to raise money) backing a shift in energy sources:

During a recent interview, Jim Barry, a managing director of BlackRock and global head of the investment firm’s Infrastructure and Investment Group, recently declared that “coal is dead.” While he acknowledged that coal will still be part of many countries’ energy portfolios, Barry said any investor who is seeking returns from coal beyond 10 years from now is “gambling very significantly.”…

And largely due to the cheap cost of renewables, Barry and BlackRock are sanguine about these technologies’ future. Barry was also optimistic during the interview on the outlook for electric cars, due to their improved range and the declining cost of battery storage. While talk of “peak oil” has been underway for years, Barry views the oil markets through a different lens, insisting that “peak demand,” not just supply, is a dynamic that investors should not ignore. As consumers embrace electric vehicles, the demand for oil will continue to decline – with the end result a cloudy future for conventional energy companies with large oil reserves on their books.

Don’t for a second underestimate the fact that senior managers at large E&P companies see investors like this as their boss and seek to deliver messages that please them.

I think some of the big mergers will help integrated solutions deliver productivity to make oil more competitive. But production productivity, and not just demand, will be crucial for the future of offshore production. The core of productivity improvements is generally mass production of all components in the supply chain by a small number of vast tier one suppliers and a network of subcontractors (who make minimal margins), and this is almost antithetical to the entire make-up of offshore. Change is coming.