The oil market is facing an unprecedented crisis as COVID-19 causes demand destruction and OPEC+ has proven powerless to stop oil prices from crashing. But behind what seems like an endless flow of bearish news, a new bull market is already forming.
CAPEX and OPEX cuts by nearly every oil and gas company on earth, forced by plummeting revenues, low demand, and brimming oil storage tanks, are the first step in what will likely become a roaring rebound in oil prices. Taking the devil’s advocate position, one could argue that the main long-term support factor for oil and gas prices is the current crisis. As global oil and gas majors, independents and NOCs announced major cuts and austerity measures, some bullish investors are already looking into the future.
As the global economy is slowly moving towards reopening, almost no one believes that demand or prices will shoot up later this year. Optimism about an average $35-40 per barrel price may seem overly positive when markets are looking at a demand plunge to the tune of 30 million bpd in May.
Norwegian consultancy Rystad Energy’s forecast that around $100 billion is expected to be cut in 2020 from E&P budgets, is being painted as a negative development. The consultancy warned that if oil prices stay below $30 per barrel in 2021, the total cut could reach $150 billion. That is a staggering amount, but one that is supported by earnings reports from IOCs, such as Shell, that clearly show a sector on life-support.
Ratings agency Moody’s is a bit more optimistic, expecting a bounce in oil prices in the medium term. They forecast that oil prices in the long-term will range from $50 to $70 per barrel. In the short term, Moody’s is less optimistic and sees the effects of CAPEX cuts trickling down from E&P companies to oilfield service companies (OFS).
Dutch-British oil and gas major Shell announced this week the reduction of underlying operating costs by $3-4 billion per annum over the next 12 months compared to 2019 levels. The also announced a reduction of cash capital expenditure to $20 billion or below for 2020 from a planned level of around $25 billion. French oil major Total also has cut organic CAPEX by more than $3 billion, while planning savings of $800 million on operating costs in 2020, from $300 million announced earlier along with a suspension of its buyback program. American super major ExxonMobil already indicated further cuts are being planned. American giant ConocoPhillips has started to cut its 2020 capital program by approximately 10 percent or $700 million, while Chevron targets $2 billion in cost savings. And the IOCs aren’t the only ones suffering, with a financial crash in US shale, Canadian shutdowns, and of course the OPEC deal.
All hope is being put on voluntary or government-enforced production shut-ins to shrink the oil glut and keep oil storage units from filling up. These measures, however, are not a feasible long-term strategy, as a total shutdown of 25-30 million bpd production is unrealistic. In a possible post-Corona environment most of the cut production will have to come back onstream.
Despite the overload of bearish news, there is some reason for optimism. Not enough attention is being given at the moment to a major fundamental factor in oil and gas production. Investment levels in oil and gas have, for almost a decade, been much lower than is needed in a normal market. Serious underinvestment hasn’t gotten much attention amid negative price developments, OPEC+ conflicts, Trump tweets, and an economic global meltdown.
The main support for oil prices in the coming 12-18 months will likely come from the lack of investment in replacing maturing oil fields. Even in a doomsday scenario, in which demand in a post-coronavirus world could be lagging 10-15 million bpd behind 2019 levels until the end of 2020 or 2021, we will need more production to come onstream again. The financial destruction of US shale, North Sea oil and Canada, combined with a growing lack of investments in low-cost producing areas, will set the market up for a new perfect storm, this time resulting in a possible oil price shock to the upside.
Analysts should realize that zero investments in existing production could threaten a production decline of 6-12 percent per year. Although there are around 70,000 oil fields in the world, approximately 25 fields account for one-quarter of the global production of crude oil, 100 fields account for half of the production and up to 500 fields account for two-thirds of cumulative discoveries. Most of these ‘giant’ fields are relatively old, and many are well past their peak of production, a majority of the rest will begin to decline within the next decade or so and few new giant fields are expected to be found. The remaining reserves at these fields, their future production profile and the potential for reserve growth are therefore of critical importance to future supply. The continuing lack of investments, that started about a decade ago is one of the most important elements of today’s oil markets.
The shale bust may grab plenty of the media headlines, but most oil supply will continue to come from the larger fields. The combination of production destruction in non-OPEC oil and the natural oil field production decline rate is a toxic one. If the market does not recognize this and continues to underinvest, oil prices will shoot up much faster than most analysts expect. 2021 could be a very bullish year for oil. Investment reductions, lay-offs, and total shut-ins are major roadblocks for a speedy and functional supply recovery worldwide. A decade of investment deficits could be doing the rest.
