The recent decline in oil prices can be pretty much summed up thusly: that escalated quickly. More than a year of steadily increasing oil prices has been wiped out in a matter of weeks as the concerns about sanctions on Iranian oil exports were more or less all for naught and U.S. production growth continues to surpass even the most ambitious expectations.
For those investors who have been anticipating rising crude prices, this recent setback might have some wondering if a return to $100, $90, or even $80 per barrel of oil simply isn't in the cards. If you ask Schlumberger (NYSE:SLB) CEO Paal Kibsgaard, though, this dip in prices may only be a deviation on a longer-term trend. Here's what Kibsgaard had to say about oil prices on Schlumberger's most recent conference call, some of the data that supports his point, and what could throw off this prediction.
It's a big world out there
Schlumberger's quarterly conference call is must-read material for any energy investor. As the world's largest oil and gas equipment and services provider, it has relationships with hundreds of oil producers ranging from the behemoth national oil companies like Saudi Aramco to the small operators in the American shale patch. Having relationships with all of these producers and knowing how they plan to spend money over the next several years gives Schlumberger a unique view on where the wind is blowing in this industry.
The recent decline in oil prices has largely been attributed to American oil production growing much faster than anyone anticipated. According to the U.S. Energy Information Administration, U.S. production increased 1.5 million barrels per day (mmbpd) in the past year and now is around 11.3 mmbpd, the highest oil production on record. Shale oil's ability to turn on the tap so quickly led to production blowing past expectations.
In Kibsgaard's prepared remarks for the call, though, he was quick to point out that global oil production is determined by a myriad of factors outside the U.S. and that those factors remain intact right now.
The international production base still accounts for around 80% of global supply and is critical to the stability of the oil market, as a mere 1% net decline would represent around 800,000 barrels per day of lower production. Production growth from the international market has, since 2013, been driven by Saudi Arabia, Iraq, Iran, and Russia, which combined have added 3.7 million barrels per day while the rest of the international production base is down by 1.5 million barrels per day over the same period.
Since 2014, many of the international operators have focused on maximizing cash flow by producing their fields harder and by prioritizing short-term actions at the expense of the required full-cycle investments. This short-term investment focus offers a finite set of opportunities over a limited period of time, and this period is now clearly coming to an end, as seen by accelerating decline rates in many countries around the world.
In addition, reduced production tailwinds from new projects that were sanctioned and largely funded prior to 2014 are now uncovering the underlying weakness in the international production base.
Why he could be right
Every day, the world loses some oil production from existing fields, and we need to replace that decline with new sources. According to research firm Wood Mackenzie, the global decline rate of existing fields is around 5%, which means that we lose about 4.6 million barrels per day of production capacity each year. While allowing for the additional production from shale and the countries mentioned above thus far, putting that much production burden on a select few places becomes increasingly difficult.
What's more, Kibsgaard also highlighted the dearth of new additional capacity projects slated to go live in the coming years. According to commodity trading group Burgraggen Holding, the global scheduled capacity additions between 2019 and 2022 are between 1.1 mmbpd and 1.5 mmbpd annually. That is well short of anticipated production decline. For global production to keep pace with current demand, sources that can quickly go to market will have to ramp up production. Otherwise, prices could be much higher.
Why he could be wrong
The idea that oil prices will head higher is basically a bet that shale and those select countries mentioned above won't be able to make up the difference from declines elsewhere. The two factors that could completely turn Kibsgaard's prediction on its head are shale growth and other global oil sources getting back to full production.
Even though OPEC production has been more or less steady over the past couple of years, the contribution from several of its member states has varied wildly. Its most productive members have been covering for incredible production declines from others such as Venezuela, Libya, Nigeria, and Angola. If these sources could be brought back to prior production capacity, it would add several million barrels per day that producers have fought hard to replace in recent years.
Then there is the contribution from shale that could continue to exceed expectations and cover up a lot of the world's production decline. In fact, the International Energy Agency is even betting on it. In its most recent World Energy Outlook report, it anticipates production from U.S. shale to double from current levels to 9.2 mmbpd by the mid-2020s and expects it to account for 40% to 75% of global production growth over that time period.
Shale's ability to rapidly respond to demand changes -- provided there is enough infrastructure to get it to market -- and its relatively lower production costs could potentially keep a lid on oil prices for a while. Kibsgaard's statement suggests he doesn't think this is entirely realistic, but we as investors shouldn't discount it.
What this all means for investors
Trying to take the pulse of the oil market has never been an easy task, and anyone making bets on oil prices over relatively short time horizons is probably better off dipping dollar bills in kerosene and striking a match.
Based on Kibsgaard's statements and the need to offset production declines over the next three to five years, it would appear that there is a good chance that we can expect increased levels of spending in the oil patch and potentially much higher prices. However, if shale can take on the herculean task of offsetting global production declines and those underperforming OPEC nations can get back on track, it's entirely possible that the oil price increase many investors have been betting on may not come to fruition.