If asked about the outlook for prices, oil company CEOs normally duck the question. And they certainly never disagree in public with Saudi Arabia, the world’s leading oil producer. This is what makes the recent speech by ExxonMobil CEO, Rex Tillerson, so interesting:
“I don’t quite share the same view that others have that we are somehow on the edge of a precipice. I think because we have confirmed viability of very large resource base in North America … that serves as enormous spare capacity in the system. It doesn’t take mega-project dollars and it can be brought on line much more quickly than a 3-4 year project. Never bet against the creativity and tenacity of our industry.”
This was a clear contrast with the earlier view of Saudi Energy Minister, Khalid al-Falih, at the same conference:
“Market forces are clearly working. After testing a period of sub $30 prices the fundamentals are improving and the market is clearly balancing. On the supply side, non-OPEC supply growth has reversed into declines due to major cuts in upstream investments and the steepening of decline rates. Without investment, that trend is likely to accelerate with the passage of time, to the point that many analysts are now wending warning bells over future supply shortfalls and I am in that camp.”
The key issue is that energy output is not just about oil prices. OPEC and non-OPEC producers are in a 3-dimensional battle for market share. Not only do they (a) have to compete with each other, but they also (b) have to remember that coal is still critically important in many countries. And then, there is (c) the climate change issue.
China is the obvious example of a major economy where power supply is still dominated by coal. But even in the US, coal still plays a major role, as the chart above confirms:
The two leading coal producers, Peabody and Arch, went bankrupt 6 months ago
But as I discussed at the time, this did not mean their mines stopped working or that coal prices soared
They are still working normally, as local power suppliers cannot easily switch to oil or gas, given their location
As the Wall Street Journal reported on Monday:
“Energy investors have long hoped that falling prices would solve themselves by driving producers into bankruptcy and stanching the flood of excess supply, but it hasn’t worked out that way”.
A second dimension is added by the dynamics of shale oil production, as the chart from the International Energy Agency highlights:
As I argued 2 years ago in “Saudi Arabia needs much lower oil prices“, Saudi never expected to close down US shale production
Saudi depends for its defence on US military support, and this support would be withdrawn if it was targeting a critical US industry
Saudi also has vast oil reserves, and it knows perfectly well that the world is moving away from fossil fuels
It therefore needs to adopt a demand-led policy, as others will instead monetise their reserves at Saudi’s expense
Saudi’s dilemma is that the world has reached, or may even be past, the period of peak oil demand, with the COP21 ratification process now complete. This is the 3rd dimension of the issue, given that COP 21 agreed to move away from fossil fuels towards renewables, and to promote much greater energy conservation.
Of course, both Tillerson and Saudi Arabia recognise these realities. But they also have to respond to the needs of their key constituencies. In EM’s case, this means recognising that investors expect them to be able to produce oil at ever-lower costs. In Saudi’s case, this means going along with OPEC pressure for output cutbacks.
It would be very dangerous for Saudi to stand out against pressure from other OPEC producers and refuse to support the idea of a production freeze. It was therefore very helpful for al-Falih that Tillerson provided “cover” for the inevitable failure of the policy. Saudi cannot now be blamed, if it turns out that prices end up lower, rather than higher.