Hope history will not repeat itself with oil pricing

Once upon a time in 1986, Opec abandoned the defence of oil prices and the market collapsed from $28 a barrels to less than $10 before Opec adopted the $18 a barrel target, which remained elusive except for brief periods. But prices did recover from the very low but never gained the original level until maybe 20 years later.

The oil industry at the time was indeed worried and went into a lot of cost cutting, efficiency seeking, restructuring and mergers and acquisitions, including those between Exxon and Mobil and BP and Amoco to name a few. Oil substitution by other energy sources went ahead regardless as governments maintained subsides for coal at a time when taxes on oil products were going up to curb demand.

Non-Opec production also proved to be resilient and went on increasing albeit at a slower rate.

Opec did gain market share as its production (including NGL) increased from about 16 million barrels a day (mbd) in 1985 to just over 31 mbd in 2000, which is close to the level it was in 1979. However, the average price of oil in the same period was close to $17 a barrel and therefore market share was slow in coming and at a tremendous cost to the organisation’s members.

This time around oil prices have gone into a tailspin and precipitously declined from around $110 a barrel in June to the lower $40 for the Opec basket of crude oils. The direction is still downward in spite of little gains in recent days as Goldman Sachs dropped its three-month forecast for Brent to $42 a barrel from $80.

Even in relative terms the current price decline is far more serious than that of 1986 and there are signs of doom and gloom in the industry. The Financial Times carried an article where it said that ‘Billions of dollars of spending on oil and petrochemicals projects have been scrapped or put on hold, with Royal Dutch Shell and UK-based Premier Oil announcing the first big cost-cutting moves of 2015’.

Shell abandoned its joint petrochemical project with Qatar Petroleum, estimated to cost $6.5 billion, and Premier is delaying a final decision on a $2 billion Sea Lion project off the Falkland Islands and the Bream project off Norway “until there was a recovery in oil prices”. Contractor fees and supplier prices are being renegotiated everywhere to lower operating costs and drilling rigs’ daily rates are falling.

Statoil is abandoning exploration licenses in high cost areas off Greenland.

Goldman Sachs is far more pessimistic as it estimates the impact of major project cancellations depriving the world of new production of 7.5 mbd over the coming decade. Its analysis is done for an oil price of $70 a barrel.

The US Department of Energy forecast on January 13 that production of US shale “will begin to tail off in the second half of the year” as ConocoPhillips, among others, announced plans to cut spending by 20 per cent in 2015 in its operations in the Eagle Ford, Permian Basin, and Bakken fields.

On the employment front, BP announced 300 job cuts in its North Sea operations and Schlumberger announced it was cutting some 9,000 jobs globally. More cuts are expected from medium- and small-sized companies. The expected decline in investments could result in a large number of layoffs within the oil and gas industry, where in the US alone it is responsible for 7 per cent of GDP.

Exploration and development in the Arctic is expected to suffer by sanctions on Russia on the one hand and by Statoil delaying its projects in the Norwegian sector of the Barents Sea.

Another telling sign is the decline of share prices of oil companies. For instance, Shell’s share lost 16 per cent between June 5 and Dec 15. Even with a later recovery, Shell is 7 per cent lower than in June. Statoil’s share fell by over 13.5 per cent in the month to 23 December.

All the above are signs of malaise in the industry now as a result of the price collapse. But these signs are yet to show in the numbers reporting supply and demand for oil. Opec in its last monthly report is even forecasting a decline in the call on Opec crude oil from 29.11 mbd in 2014 to 28.78 mbd in 2015, which means that non-Opec production would still increase.

It may be too early to make a judgement, but as far as Opec is concerned let us hope that it will not take another 15 years for Opec to gain market share and recover prices.

The writer is former head of Energy Studies Department at Opec Secretariat in Vienna.