I have just returned from Riyadh where I attended as a panelist the IEA-IEF-OPEC Symposium on energy outlooks. This was followed by my participation as a discussant in a Thought-Leaders’ Roundtable co-sponsored by the IEF and KAPSARC. Both events were aimed to contribute towards a better understanding of developments that are shaping oil markets and investment trends.
As usual the main part of the Symposium was intended to further explore the areas of consensus and divergence between the energy outlooks regularly released by the IEA and OPEC. In practice, this takes a form a “beauty pageant” between the two institutions. However, for the first time since initiated in 2011, this exercise was complemented by an independent review and benchmarking prepared by Duke University Energy Initiative that greatly enriched the discussion. The Symposium also addressed the many uncertainties stemming from current energy outlooks and how likely they are to affect investment decisions.
The thought leaders’ roundtable discussion, which adopted the same format than the symposium, focused on oil market volatility, investment and spare capacity. In this latter respect, the key question explored was whether US shale oil can act (bottom up) to substitute for (top down) output regulation by OPEC and Saudi Arabia. Performing the role of swing producer assumes that the atomized independent US shale oil producers can offer global market the needed spare capacity. The corollary is that, provided US crude oil exports are no longer prohibited, world oil prices would be mainly decided by the marginal cost of producing shale oil.
As far as I am concerned I covered OPEC investment outlook. More precisely, I attempted to answer the two following questions: First, is OPEC willing to invest if the oil price, at which global supply and demand balance, is widely uncertain? Second, should OPEC be willing, is it able to invest? Before answering these questions, it was useful to briefly explore what the future holds for OPEC.
OPEC will continue to face long-term structural changes and uncertainties in both its external and domestic landscape. On the global stage, the profound shifts in energy demand and energy supply patterns we have been witnessing in recent years are likely to deepen. Surely, there will be further effects of the energy security-climate change nexus on petroleum markets. On the demand side, efficiency progress in vehicles and alternative transport fuels will likely continue reducing the importance of oil. On the supply side, current challenges from the potential impact of light tight oil (LTO) and other unconventional oil sources will become more compelling should the ‘US Shale Revolution’ spread successfully to other parts of the world. Looking further ahead, one wonders what other ‘energy revolutions’ lie in store at the confluence of technology and innovation, politics and policy, and the economics of viability of frontier oil development?
On the domestic front, OPEC members are heading down an unsustainable energy consumption path causing huge opportunity costs from lost export revenues. Policy makers’ responses to rapidly rising energy demand (resulting from profligate consumption patterns) have tended to focus more on the prospect of supplying alternative energies and less on managing demand. While energy efficiency pronouncements have yet to materialize, energy pricing and subsidy reforms remain a real policy and political conundrum. In these circumstances, our projections indicate that export share of oil production is likely to shrink further from the current 60% to just 40% by 2040.
In the medium term, OPEC will face difficult internal dynamics, even if it manages to retain global market share. This stems from the fact that Iraq, Iran and Venezuela are major potential sources of capacity and output growth. Normalization of Iran’s relations with the West and a return to stability in Iraq would lead to production gains that could challenge Saudi Arabia’s leadership. Furthermore, growing exports of oil products risk eroding the demand for crude oil in some importing countries. In this respect, Saudi Arabia, which has recently invested heavily in export-oriented refineries, may now be perceived more as a “refiner” whose influence on crude oil prices is diminishing. Indeed a shift from trading crude to trading products risk rendering quotas on production meaningless as a tool to govern exports and prices.
But is OPEC willing to invest if the oil price at which global supply and demand balance is widely uncertain? Among other factors, price trends influence consumption and production, which in turn drive price changes. To assess the range of potential interactions between supply, demand and prices, the 2014 IEO (US EIA) considers three price cases: the Reference (central) case where prices trend towards $141 per barrel in 2040 (in 2012 dollars), and two alternative cases: a Low Oil Price and a High Oil Price cases where prices hit $75 and $204 per barrel, respectively by 2040. These three cases illustrate some, but not all, of the range of uncertainties in the future of the oil market.
As oil prices are likely to oscillate between these extreme scenarios, the corresponding call on OPEC oil would be expected to be between 43.7 million b/d and 65.3 million b/d in 2040. Therefore a major challenge for OPEC and its members as they develop their investment strategy will be finding a trade-off between pre-commitment and flexibility before such wide uncertainty is resolved.
Should OPEC be willing, is it able to invest? Our perceptual mapping of the energy investment climate, which combines three attributes (potential investment, country risk and the enabling environment for the development of the oil industry), suggests a poor overall score for more than half of the OPEC countries, among which are those previously identified as having the biggest potential for growth. In addition, in the context of low oil prices, financing is emerging as a major impediment to investment.
Financing is a pivotal element in investment decisions. It is basically determined by the structure of capital requirement, which we have found to be one-third debt and two-third equity for OPEC medium-term energy investment. Equity, which is a dominant feature of the upstream industry, is sourced internally either through corporate retained earnings or, more significantly, through state budget allocations. Therefore, its funding depends on the extent oil prices recover towards countries’ fiscal break-even prices. Accordingly, most member countries will hardly be able to finance their share of upstream investments so long as their fiscal break-even costs are above the ‘normal’ OPEC weighted average, which, as a result of continuing expansionary fiscal policies, has remained at $100-plus per barrel.
Finally, debt, which is a dominant feature of the downstream industry, is sourced externally. Despite recent success in the issuance of bonds and sukuk, predominantly in the GCC, external financing of energy investment continues to rely heavily on a still distressed dollar-denominated loans market, notwithstanding greater involvement of export credit agencies (ECAs) and local banks. This market will hardly fully recover without international banks
renewing their commitment to the OPEC area. Meanwhile, meeting the potential debt requirements will remain a daunting challenge.
In conclusion, more than any other factor, uncertainty about future price paths is likely to hamper investment decisions and the pace of OPEC capacity expansion. The higher the price the more incentive there is to invest; but high prices entail lower call on OPEC oil, leading in turn to lower prices. The current down price cycle, which is reviving old dilemmas (and soon dramas) is not conducive to investment in general. In this context, OPEC investment outlook could be further undermined if policymakers fail to address new challenges, including: rationalizing domestic consumption to generate greater petroleum export revenue; improving the investment climate and creating a better enabling environment for business; as well as moving towards sustainable, non-oil-rent-dependent alternative sources of funding
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