OE15: Supply and demand

When the oil price drops, people want to know how long the decline will last and when it will go back up. Manouchehr Takin, a London-based international oil and energy consultant, tried to make sense of the economic side of low oil prices at yesterday’s SPE Offshore Europe breakfast briefing.

Takin. Image from OE Staff.

Comparing the current downturn to oil price drops of decades past, one thing seems certain from the data: when supply outweighs demand, the oil price plummets, leading to not only a reduction in production but declines in investment, which in the long-term leads to future production shortages, and the cycle will continue, he said.

For the industry, it’s obviously not great news. Takin noted that there are serious budgetary constraints and economic/social crises for all exporting counties – OPEC and Non-OPEC. The fall in price has also meant a fall in investment and massive staff reductions in world oil industry, not least in the North Sea.

But ultimately, the lack of investment, means that when demand returns, there could be supply shortage. “If investments are falling by 30-50%,” Takin said, “less investment, means there might not be enough oil.” However, for the world economy, the news is less bleak. The low price could lead to global growth being boosted by 0.3-0.8%.

Takin, an Iranian native who worked for the OPEC Secretariat in Vienna for nine years, presented many factors that come into play with oil price fluctuations. Because not only is the price affected by supply and demand tensions but also financial players who can accentuate the price as well.

“For two to three decades the price of oil was US$20/bbl,” Takin said. “You forget about those times when it’s been $100, but we had it for decades.”

One day the market woke up. In 2008, oil reached a high of $147/bbl when only five years previous in 2003, it was $25/bbl. How did this happen? Well, the simple answer was that the market conditions were ripe for a price hike.

Looking at the previous downturn in the late 1990s, OPEC had made a decision to ramp up production in 1997, despite a recession in the Middle East. That decision caused the price of oil to fall under $10/bbl in 1998. Takin noted that it took two years for the price to go back up. But because of the lowered oil price, oil companies cut investments due to a lack of confidence in the market.

“So, there was five years of underinvestment by companies,” Takin said. “Based on the oil price collapse, companies didn’t have confidence price would go up. When they were doing project evaluations, their cut off was $14-15/bbl up until 2002-2003.”

Takin said that when investment began 2004 onwards, and the global economy began to recover, there wasn’t enough oil supply. “Demand was increasing, but supply could not catch up, the imbalance kept pushing up the price of oil.”

The shortage of supply gave way to numerous stories in the media discussing peak oil and the end of oil as we know it. Takin said that this perception of peak oil and running out of oil accentuated the climb to $147 by July 2008. However, just as quickly as the price rose, it soon fell, plummeting to $30/bbl by yearend 2008.

By 2009, the US shale revolution began, due to new technology and increased investment, reversing a trend in declining US crude production, where peak production of 10,000 b/d was achieved in the 1970s, and quickly fell through the next three decades.

But by 2014, conditions were once again ripe for the cyclical market downturn. OPEC met in Vienna and decided not to reduce supply and thereby reduce their market share, Takin said.

Figures from the OPEC Monthly Oil Market Report from February 2015, show that in 2013-2014 the world’s oil demand sat at 1 MMb/d, while the world’s oil supply (excluding OPEC) sat at 2.2 MMb/d, Takin said. The need for OPEC crude sat at -1.2 MMb/d. Takin said that the oversupply would be worse had production from Iran and Libya been a factor.

For 2016, Takin notes that non-OPEC production will increase by 0.3 MMb/d, but excess supply will still persist, which means a continued downward pressure on price. In order to balance market, excess oil supply has to reduce 2-3 MMb/d, he said.