Halliburton (NYSE:HAL) President Jeff Miller recently provided investors with some unique insights into the oil market on the oil-field services company's fourth-quarter conference call. Here are his comments on supply, demand, and the history of oil market downturns, which offer a significant clue on when the market could turn around.
Miller began his comments by comparing the current oil demand forecast against potential supply:
Although oil demand growth expectations for 2015 have weakened, it is still growth. Demand is forecast to increase by an estimated 900,000 barrels per day. Keep in mind the steep decline curves are still at work. We estimate the average annual production decline rates for unconventionals in North America are in excess of 30%, and much higher in some areas. Depending on the ultimate trajectory of the rig count declines and the backlog of well completions, we believe that North America crude production could begin to respond during the back half of the year. Internationally, decline rates have become more pronounced in several key markets over the last couple of years. In areas like Angola, Norway, and Russia historical growth has given way to net production declines in the last year. While decline rates in markets like Mexico and India have actually accelerated.
That projected 900,000-barrel demand increase makes clear the world has not suddenly abstained from using oil. It might be using less than supply at the moment, but that moment could quickly pass as production peaks and then naturally falls. That process is already under way in a number of countries, and U.S. production could peak and begin to decline in the second half of the year.
This actually could be a big problem if oil companies underinvest in the years ahead, according to Miller.
... we believe that any sustained period of underinvestment due to reduced operator spending could lead to an increase in commodity prices. And this largely ignores the possibility of short-term disruptions due to geopolitical issues. So the long-term fundamentals of our business are still strong. But it is clear we are heading into an activity downturn.
It's quite possible a sustained period of low oil prices could eventually cause a price spike, as oil companies can't quickly ramp up production capacity to meet demand should it grow faster than forecasts currently predict.
Looking at rhyme and reason
Miller then addressed the history of oil market busts: "We can look at previous cycles for insight. And while history doesn't always repeat, sometimes it rhymes."
He added that:
In North America we're looking at the rig count decline relative to past downturns. After a plateau through much of the fourth quarter, the rig count has dropped sharply over the last two months and is already down 15% from early December. This trajectory is similar to both the 2001/2002 cycle and the 2008/2009 cycle. And in those cases we experienced a rapid correction to the rig count going from peak to trough over a three-quarter period.
So history suggests the rig count for this downturn will bottom out over three quarters, meaning there is likely still significant uncertainty to muddle through. That said, U.S. rig counts are widely seen as a key to finding a bottom in the oil market.
Miller then turned his attention to international markets, which behave a little bit differently.
In the international markets our projects and contracts tend to be longer term in nature than in North America. Historically this has resulted in reduced year-on-year volatility. However, nearly all of our customers are currently reassessing their priorities and looking for efficiency, and even more so in the offshore space. It's important to note that this group has been quick to react to decline in commodity prices with the first moves being made in mid-2014 at sub-$100 oil. Although projects already under way are continuing to move forward, generally speaking we are seeing significant reductions in new work being tendered and projects that can be delayed are moving to the right.
While the international market usually is slower to react than onshore markets in North America, producers did reduce spending earlier than normal this time around. Some of that had to do with the out-of-control offshore costs in recent years, which had already led producers to start cutting back when the economics began to worsen, a process that has only accelerated as oil prices plunged.
All of this suggests the current downturn is right on schedule. While this doesn't mean the downturn will be short, it does indicate producers should have a lot more clarity on the situation by the second half of this year. That clarity will make it much easier for everyone to plan for the future.