OPEC’s Dilemma
The oil world cycles of 2003-2023
Ray Leonard: Hyperdynamics
Art Berman: Labyrinth Consulting
University of Arizona
Tucson, March 29, 2016
“Prediction is very hard, especially
about the future” - Yogi Berra
Resources
(Geoscientists)
Technology &
Operations
(Engineers)
Politics
(Sociologists)
Profitability
(Economists)
Cautions in viewing
predictions
—  End of history
illusion
—  Smartest guy in
the room
—  Consider the
source
OPEC’s Dilemma: the oil world cycles of 2003-2023
—  Through its history, the oil industry has consistently been through cycles
of shortage, leading to price spikes, increased production and
overproduction, then a price collapse leading to reduced production and
shortage, beginning the cycle all over again.
—  The factors driving these cycles include geology, engineering
(technology), economics and politics.
—  The first quarter of the 21st century is proving to be a continuation of this
pattern. An extended period of low prices (1986-2003) was followed by a
20-year period which included three price increases due to shortages
separated by two price collapses.
—  OPEC has a strength and weakness: The strength is that they possess the
only excess production capacity, giving them a way to control the market.
The weakness is that oil revenue forms a disproportionate role in their
economy and government revenues leaving them vulnerable to low prices.
The Oil World of 2003-2023
This 20 year period can be divided into five periods, representing
the boom and bust cycles of the industry. Each period began with
a clearly defined event.
—  The end of the glut: (Oct. 2003-Sept. 2008) An increase in demand due to strong
—
—
—
—
world economy combined with the peak production of conventional oil in 2005
resulted in an oil-price rise and spike, ending an extended period of low prices
The price collapse and rapid recovery: (Oct. 2008-Dec. 2009) A drop in demand
due to worldwide economic crisis was met by a swift OPEC production cut leading
to a price recovery
The rise of the high cost oil: (Jan. 2010-Oct. 2014) Supported by high prices and
cheap credit, high-cost unconventional, heavy oil and deep-water oil production
dramatically increased. Loss of production due to political events in the Middle East
and in North Africa preserved demand/supply balance and high prices.
Price collapse and rebalancing the market: (Nov. 2014-2018) Overproduction of
high cost oil plus re-emergence of Iran and Iraq production caused price collapse.
OPEC refused to cut production, preferring to preserve market-share and allow
low prices to reduce high-priced production and increase demand.
New Equilibrium: (2019-2023) Price rises once demand overtakes supply and
excess inventory from 2014-6 overproduction sold. Cancellation of high price
projects in 2015-2017 period facilitates price rise by end of decade.
The Oil World in 2003
—  Oil prices had averaged $34/bbl.
—
—
—
—
(2015 dollars) since the price collapse
of 1986
Non-OPEC production has risen for
10 consecutive years but would
plateau in 2004
86% of oil production is low-cost
conventional in 2003. Most of
unconventional in form of NGL’s
New Technology has been developed
for deep-water and heavy oil
production but economics are
marginal at current price
Increases in demand had been
matched by supply increases in
various non-OPEC countries since
1993; the latest was the production
renaissance in Russia with 50% rise in
2000-2003, a majority of the nonOPEC increase in that period.
2003 World Oil Production
Conventional Oil
9%
NGL's
3%
Heavy Oil
Deepwater
2%
86%
Plateau of Non-OPEC
Production
17 Years
Of
Low Prices
End of the glut and the price spike of 2003-2008
—  In October 2003,
Mikhail Khodorkovsky,
CEO of YUKOS was
arrested,YUKOS
eventually destroyed,
leading to reduction in
rate of Russian oil
production increase.
—  With only minimal
Russian production
growth after 2003 and
steady decline in other
non-OPEC conventional
production, oil
production reached a
peak and began to
decline in 2005.
LEONARD Russian
Prod. Prediction
IEA NOV, 2003
Actual Russian
Production
Khodorkovsky
Arrested
70000
60000
50000
40000
2000
30000
20000
2005
10000
2010
0
FSU
ROW
OPEC
Total
Conventional Conventional Conventional Conventional
End of the glut and the price spike of 2003-2008
—  With strong GDP growth
(averaging over 4%), world
demand continued to grow and
with OPEC discipline holding,
significant shortages resulted in
a price rise from $30/bbl. in
late 2003 to $140 bbl. in
September 2014.
—  The price rise supported the
growth of high-cost exploration
and production. In particular,
these years can be viewed as the
“golden age” or breakthrough
years of deep-water
production, which increased
280% in the 5-year period.
Source: The Economist
Increased GDP
& Oil Demand
6
5
4
3
2
1
0
2000 2001 2002 2003 2004 2005 2006 2007 2008
North
America
Latin
America
Africa
Rest of
World
The price collapse of 2008 and rapid reaction of OPEC
Demand significantly exceeded supply in 2007
to 1Q 2008 resulting in price rise from
$54-$132/bbl. in 3Q 2008.
Three consecutive quarters of oversupply,
along with demand reduction due to world
economic crisis resulted in price collapse to
$43/bbl. by January 2009.
OPEC cut production (Saudi Arabia 40% of
cut) in Q4 2008-1Q 2009 to restore market
balance, leading to recovery to near $80/
bbl. by end 2009.
Price fluctuation was due to one specific event
(demand reduction due to world economic
crisis) that could be handled by OPEC
reaction
Source:IEA
Source: Capital Economics,
Bloomberg
The rise of high price oil (2010-2014)
Five factors led to an unprecedented period of
continued high oil prices and resultant supply
of high cost unconventionals. By late 2014,
one third of world oil production was deepwater + unconventional.
2015 World Oil Production
Conventional Oil
NGL's
Deepwater
Shale Oil
Source: IEA
Heavy Oil
5% 5%
9%
14%
67%
—  World economic growth: Led
by China, the world economy
expanded reaching 5% GDP
growth in 2010. World oil
demand expanded
dramatically that year,
restoring the $100/bbl. price
by 2011.
—  Political turmoil: Various
factors, from revolution and
civil war to sanctions,
removed about 3 MMBOD
production from the Middle
East and North Africa in the
2010-2012 period. This
production loss was largely
maintained through 2015.
Production changes (MMBOD) since Q1 2010
5.00
4.00
Libya
3.00
Iran
2.00
Yemen
1.00
Syria
0.00
Canada
-1.00
USA
-2.00
Balance
-3.00
-4.00
2013/3 2013/4 2014/1 2014/2 2014/3 2014/4 2015/1 2015/2 2015/3 2015/4
The rise of high price oil (2010-2014)
Federal$Funds$Interest$Rates$January$2000>June$2015$
Brent#Price#
$160#
$140#
6%#
$120#
5%#
$100#
4%#
$80#
3%#
$60#
2%#
$40#
1%#
0%#
$20#
Source:$$EIA,$U.S.$Bureau$of$Labor$StaHsHcs,$U.S.$Federal$Reserve$System$$
Jan000#
Jun000#
Nov000#
Apr001#
Sep001#
Feb002#
Jul002#
Dec002#
May003#
Oct003#
Mar004#
Aug004#
Jan005#
Jun005#
Nov005#
Apr006#
Sep006#
Feb007#
Jul007#
Dec007#
May008#
Oct008#
Mar009#
Aug009#
Jan010#
Jun010#
Nov010#
Apr011#
Sep011#
Feb012#
Jul012#
Dec012#
May013#
Oct013#
Mar014#
Aug014#
Jan015#
Jun015#
Interest$Rate$
the USA, starting in 2009,
low cost financing was
available for development
projects that were only
marginally profitable even
at high oil prices
—  New Technologies:
Breakthroughs in deepwater and heavy oil
production technology
from the previous decade
continued to show results,
due to long cycle time of
projects. Canadian
synthetic crude and crude
bitumen production
doubled in 2010-2015.
Interest#Rate#
7%#
$0#
WTI$Oil$Price$2015$US$Dollars$
—  Low interest rates: Led by
The rise of high price oil (2010-2014)
point: Fracking
—  Fracking: the marriage of fracking and horizontal
—
—
—
—
—
drilling technology resulted in a production
boom in the USA, facilitated by good fiscal
terms, availability of capital and service
companies and public databases
By February 2014 production rose to
approximately 3.7 MMBD crude + 1.5 MMBD
NGL in the US and Western Canada
Approximately 60% of reserves and production
came from two plays; the Eagle Ford and Bakken
Production is characterized by high capital costs
and rapid well decline rate (60-70% in first year)
Even with the high oil prices, capital
expenditures exceeded cash-flow pushing
producers in debt
How did the production boom occur? E&P
Companies focusing on the shale plays
became the sub-prime derivative of the
post-Financial crash period. Shale oil
projects had access to almost infinite capital with
no short term performance requirements other
than making interest payments and avoiding
debt covenants
5th
The rise of high price oil and the
economics of Fracking Contour maps show
amount of recoverable
oil per well. (Labyrinth
Consulting)
—  Ultimate recovery per well
varies widely in all of the plays,
even in the Bakken and Eagle
Ford, so a single “break-even”
price can not be accurate. Often
what is quoted is the “breakeven” price for the best quality
reservoirs.
—  All shale plays are characterized
by “sweet spots” with higher
ultimate well recoveries
—  In both Bakken and Eagle Ford,
the most efficient operators on
best acreage have a “break even
price” around $45/bbl. Most
producers need $55-70/bbl.
—  These are the two best shale
plays. Break-even costs on
other plays are generally higher.
Eagle Ford Shale
Bakken Shale
Rebalancing the Market: the price
collapse of late 2014
—  By mid 2014, the increasing supply
—
—
98
ConsumpGon
Source: IEA
BrentPrice
$120
BrentPrice
97
$100
Supply<Consump?on
Supply>Consump?on
95
$80
94
93
$60
92
$40
91
SupplyandConsump?on
90
$20
89
Jan-16
Feb-16
Dec-15
Oct-15
Nov-15
Sep-15
Jul-15
Aug-15
Jun-15
Apr-15
May-15
Mar-15
Jan-15
Feb-15
Dec-14
Oct-14
Nov-14
Sep-14
Jul-14
Aug-14
Jun-14
Apr-14
May-14
Mar-14
Jan-14
Feb-14
Dec-13
Oct-13
Nov-13
Sep-13
Source:EIASTEOMarch2015&LabyrinthConsul?ngServices,Inc.
Jul-13
88
$0
BrentCrudeOIlPrice(DollarsPerBarrel)
96
Aug-13
—
Supply
MillionsofBarrelsofLiquidsPerDay
—
of deep-water + unconventional
production was overwhelming
demand.
After 2013, there were no further
reductions from Middle East/North
Africa turmoil to offset this.
In November 2104, with price
collapse clearly imminent, OPEC
met but did not agree on a price cut
(in contrast to 2008) resulting in fall
by early 2015 to below $50/oil.
Following a brief rally to $60/bbl. in
spring 2015, the price fell to $30/
bbl. by January 2016.
The current oversupply is about
1.12 MMBOD. (March 2016) In
addition, the world has about 430
MMB excess oil stored from the
oversupply of the 2014-2016 period.
WorldLiquidsSupplyandConsump?onJuly2013-February2016
Rebalancing the Market:
OPEC’s Dilemma
The Current Oil Price Collapse and the Shale
Revolution
—  The current oil price collapse was caused by overproduction of unconventional oil funded by debt.
It is the classic “bubble”.
—  OPEC’s dilemma is whether to cure the price
collapse by reducing production in the short term,
sacrificing market share or to allow a gradual
market correction, absorbing the pain of low oil
prices for a number of years.
—  The brief price rally in spring 2015 (to $60/bbl.)
and renewed investment in high price oil
demonstrated to OPEC that the price drop of
November 2014-March 2015 had not changed the
market fundamentals.
Rebalancing the Market: OPEC’S Dilemma
In spring 2015, OPEC faced 3 choices
1.
2.
3.
Cut production to allow rapid price rise to
$80/bbl. (as in 2008) Taking this approach
would likely allow the US shale producers
to continue their production increase,
thereby sacrificing OPEC market share
Hold production at 30 mmbod quota
allowing market and price to rebalance by
2016
Increase production to 31.5 mmbod to
keep price at level that would break the
shale oil investment cycle
www.icis.com
In spring 2015, the Gulf States of OPEC decided on the third option and
increased production to 31.5 MMBOD in order to keep the price low and
break the investment cycle of high cost shale oil, heavy oil and deep-water
oil. This would also increase demand and preserve their market share.
Rebalancing the Market:
OPEC’S Dilemma
As 2016 begins, OPEC strategy appears to be working:
—  The lower oil price raised world demand from 1.1% increase
per year from 2011-2014 period to 1.8% increase in 2015,
adding about 0.6 mmbod demand above expectation to the
market by year end. Future increases with continued low price
of about 1.2% per year can be expected.
—  After 6-month delay, US shale production began dropping in Q2
2015 at a rate of 20 kbopd per month, then Q4 2015 at 63 kbpd
Jan-Feb 2016 at 75kbpd By Q3 2016, if current price persists,
US production will have dropped nearly 1.2 mmbod from peak.
—  The industy has reduced capital spending in 2015-2016 by 19%
(48% cut of E&P spending) from the 2014 level, delaying
high cost projects taking approximately 20 billion barrels from
the market.
oilprice.com
Rebalancing the Market:
OPEC’s Dilemma
Why $30 oil cannot last
$/bbl.
Lifting costs: deep-water and unconventionals
100
90
80
70
—  Unlike 2003, in 2015, more than
30% of the world’s oil production
is high cost unconventional and
deep-water, unprofitable at this
price
—  Middle East/North Africa OPEC
countries need $50-$120/bbl. oil
price to support their countries
budgets
3000M
Marginal
60
50
1500M
40
Bakken
Eagle
Ford
30
20
Deepwater
10
0
Canada
Orinoco
Shale
Oil
8.7 MMBOD 4.4
Heavy
Oil
4.4
Shale Oil
Conventional
NGL
12.8 MMBOD
Note: heavy oil (ave. 20%)and NGL’s (ave. 40%) sell for
a significant discount to normal crude.
100%
90%
Conv.
80%
70%
Heavy Oil and
Tar Sands
Shale Oil
60%
50%
40%
NGL Total
30%
20%
Deepwater
10%
0%
2000
2005
2010
2015
OPEC’s Dilemma:
New Equilibrium and price rise (2019-2023)
—  The balance of supply and
demand, assuming no OPEC
cut, is now only predicted to
occur in early to mid 2017.
—  At that point, drawdown of
the excess inventory is likely
to begin, a process that could
take as long as 18 months.
—  It will be facilitated by the
drop in supply due to the
budget cuts and project
cancellations of 2015-2016
—  Significant price rise (above
$50/bbl.) is only likely to
begin in 2019
Oil price based on 5-year Brent spread
(Bloomberg) 2016-2020, 2021-2023 price authors
projection
The future of the profession
AAPG Membership reflects the
cyclical nature of industry hiring:
•  In 1983, during the “boom”
cycle, new membership peaked
as the older peak from ‘50’s
“boom” neared retirement
•  In 1996, during the lean years,
new membership was low and
attrition reduced the peak
membership of the “boom”
years
•  In 2011, as a new “boom” was
taking place, a new hiring cycle
started while the membership
of the early 1980’s “boom”
nears retirement Prices in 2011 dollars
The future of the profession
—  The price collapse of 2014 is likely to
—
—
—
—
extend through 2017 with gradual rise
starting 2018,reducing budgets for new
hiring in next two years
However, another cycle will soon begin
for the reasons outlined in this
presentation
The retirements of the class of 1975-85
will produce openings for a new
generation of geoscientists
In face, the two biggest issues in long
term planning of oil company
executives are the retirement of the
class of the “boom” of 1975-1985,
known as the Great Crew Change
and how to attract skilled new entrants
The future for a new entrant to the
profession of petroleum geologist, with
patience and perseverance, is bright
Source: Oil and Gas
Executive Outlook
2016. Reinsvold &
Assoc.
OPEC’s Dilemma: Summary and Conclusions
—  The pattern of “boom” and bust” in the oil industry, typical of the 20th century will
continue into the 21st century despite any efforts to control it
—  Each price collapse is different. The 1986 collapse lasted so long because there
were abundant sources of low cost conventional oil to be exploited and was “cured”
by the worldwide peak of conventional oil production. The 2008 collapse was due
to a specific economic event, not a fundamental oil market event and was quickly
rectified by OPEC. The 2014 collapse is between the two. While it is caused by a
fundamental event (rise of the deep-water and unconventionals production) the
current price cannot support a third of the world’s oil production, therefore it
cannot last as long as the 1986 collapse.
—  OPEC’s reaction, to let market forces reduce the high cost production and bolster
demand, was rational and will ultimately be successful in pushing the price to a
sustainable level in the range of $60-80/bbl. in the early part of the next decade.
—  Geopolitical events and breakthroughs in technology must be considered “wildcards” that could upset well reasoned predictions!