Mark Lewis for Kepler Cheuvreux (no url): “The IEA yesterday released its 2014 World Energy Outlook (WEO), the annual benchmark reference document for energy-market practitioners.”
“The big picture is largely unchanged from last year, and we find it particularly interesting that despite the recent precipitous drop in oil prices the IEA has re-iterated the point it made in its World Energy Investment Outlook published in June, namely that huge investments in new supply will be required in coming years, and this will require sustained higher oil prices over the next two decades. Indeed, the 2014 WEO puts the matter very bluntly (p.95): “The apparent breathing space provided by the rise in non-OPEC output over the next decade is in many respects illusory.” We concur with this view. Indeed, we think that while the current febrile market and the Saudis’ apparent willingness to accept lower prices for a period could put even more pressure on crude prices in the near term, prices will ultimately have to rise back towards $90/bbl by the end of 2015/beginning of 2016, and back towards $100/bbl by Q1 2017. In addition, although the IEA has very modestly increased its projections for the share of electric vehicles (EVs) in the road-transportation market over the next two decades, we still think it is greatly underestimating the likely penetration of EVs by 2035-40. As a result, we continue to think that even if – as both the IEA and we ourselves assume – sustained higher oil prices will be required over the medium to long term in order to encourage new supply, this will not necessarily save the oil majors from the risk of stranded. We therefore re-iterate our view that the oil majors need to become” energy majors” as first set out in our report Toil for Oil Spells Danger for Majors.
IEA leaves long-term oil price projections essentially unchanged: Figure 1 shows the IEA’s updated long-term oil-price projections by scenario out to 2040, and Figure 2 the equivalent projections from the 2013 WEO published this time last year. The Agency has now extended its forecast range out to 2040 for the first time (last year’s projections only went out as far as 2035), and the updated estimates for its base-case scenario – known as the New Policies Scenario (NPS), are essentially unchanged from last year’s WEO.
As can be seen, the IEA is now projecting a Brent price of $112/bbl in real terms by 2020 (which equates to $131/bbl in nominal terms). This compares with a price forecast for 2020 of $113/bbl in real terms ($136/bbl nominal) in last year’s WEO. For 2030, the 2014 WEO is projecting a price of $123/bbl in real terms by 2030 ($181/bbl nominal), and this again is very close to the $121/bbl in real terms ($183/bbl nominal) projected for 2030 in the 2013 WEO. Finally, for 2040 the 2014 WEO is projecting a price of $132/bbl in real terms ($244/bbl nominal), which again – after adjusting for the time difference (the 2013 WEO only went out as far as 2035) – is very close to the $128/bbl in real terms ($216/bbl nominal) that last year’s WEO was projecting for 2035.
In short, what is clear is that the IEA has not changed its long-term assumptions on oil prices by very much at all. On the contrary, it remains of the view that sustained higher oil prices will be necessary to incentivize the required investment in new supplies over the medium to long term. So, why is this the case?
Long-term supply growth remains overwhelmingly dependent upon unconventional crude and NGLs: The main reason that the IEA sees a need for sustained higher prices out to 2040 is that it remains of the view that the profile of supply will change radically over the next 25 years, with the supply of conventional crude oil falling out to 2040 versus today, and the world therefore increasingly dependent on unconventional crude oil (US shale oil, Canadian oil sands, and Venezuelan extra-heavy oil), and natural-gas liquids (NGLs). Again, this is very much the same message that it was broadcasting in the 2013 WEO, and the argument in favour of its projected higher prices is therefore unchanged: unconventional sources of crude oil are on average significantly more expensive than conventional crude oil, and sustained higher prices will therefore ultimately be necessary if the required investments in these sources of supply are to be realized.
Moreover, we would highlight that even the projection that conventional crude-oil production will decline by 2.2mbd out to 2040 can be viewed as optimistic given that this assumption still relies very heavily on big increases in conventional supply from Iraq (+5.1mbd) and Brazil (+3.6mbd). We say this because we think there are serious question marks over the ability of both of these countries to deliver on these projections.
In short, long-term oil-supply growth remains dependent on a very limited number of countries (Iraq and Brazil for conventional crude, and Canada and Venezuela for unconventional), and on high-cost sources of production (especially oil sands, extra-heavy oil, and shale oil).
That being the case, why have oil prices been so weak lately, and could they fall further in the short term before reverting to a rising trend?
Prices could always fall further near term, but we see reversion to rising trend by end 2015: The sharp sell-off in oil prices since June of this year reflects four main factors in our view: (i) a declining geo-political risk premium after the slowdown in the advance of the jihadist-terrorist Islamic State (IS) group in Iraq following enhanced military action against IS by the US and its allies and increasing production in Libya; (ii) a slowdown in demand, especially in emerging markets; (iii) continuing strong growth in US shale-oil production, and (iv) price-cutting by Saudi Arabia to customers in Asia and North America.
Of these, we think the most important one in terms of injecting greater short-term negative sentiment into the market is the last one, as hopes of a stabilization In prices rested previously on co-ordinated action from OPEC, action that now looks very unlikely before the first half of 2015 given the recent actions by Saudi Arabia and comments from key Saudi decision-makers. Indeed, in our view the Saudis could easily endure prices in the range of $70-80/bbl over a 12-month period, and may indeed be keen to test the strength of other producers such as Iran, Russia, and the US shale players in such a price environment.
Against this backdrop, the risk must be that Brent prices could fall lower over the next few weeks and months, perhaps even testing the $70/bbl level. However, we do not see a big risk of prices remaining below $80/bbl beyond Q2 of next year. This is for two main reasons: (i) prices at or below $80/bbl for a prolonged period will almost certainly force further delays/cancellations of major new projects while also prompting a significant slowdown in the pace of US shale-oil drilling, thereby forcing the market to re-assess the supply outlook; and (ii) other OPEC members are likely to press Saudi Arabia and Kuwait (the two main hold-outs) much harder for supply cuts if prices remain under sustained pressure over the next 7-8 months.
As a result, we see Brent prices back in a range of $85-90/bbl by Q4 2015/Q1 2016, and at or near $100/bbl by Q1 2017. Thereafter we would expect oil prices to trend higher in line with the IEA’s updated price projections.
Conclusion: no recoil from the toil for oil – 2014 WEO re-affirms our long-term thesis: As we explained in our report Toil for Oil Spells Danger for Majors (15 September 2014), our Energy Return on Capital Invested (EROCI) analysis indicates that renewables are already surprisingly competitive with marginal new oil projects, and with renewables set to see further cost reductions over the next two decades, higher long-term oil prices will in our view be no guarantee against asset-stranding beyond 2025 for the oil majors’ marginal new projects. The 2014 WEO sees global oil demand 14mbd higher in 2040, with c.4mbd of this for light vehicles in Asia. And although the IEA has slightly increased its projections for EV penetration in the road-transportation market by 2040 versus its assumptions in the 2013 WEO – it now sees EVs displacing c.800kbd of oil demand by 2040 versus the 240kbd it saw being displaced by 2035 in the 2013 WEO – this still makes future demand projections highly vulnerable to a faster take-up of EVs than the IEA is assuming.
As a result, if the improving economics of renewables versus oil spurs a faster take-up of EVs in China than the IEA is assuming, this could threaten the viability of the marginal barrels beyond 2025. Higher long-term oil prices could thus create asset-stranding risk for new projects undertaken today at the higher end of the cost curve, a risk we think the majors should now be taking very seriously. Indeed, we think the oil majors now need radically to re-think their business model and become energy majors.”
Future Today
