AFPM ’15: The US as a swing crude producer? Go figure

Focus story by Ignacio Sotolongo

HOUSTON (ICIS)–During the 1990s dot-com stock market bubble, Alan Greenspan, the then chairman of the US Federal Reserve, referred to the euphoria as “irrational exuberance”. Whether he coined the phrase, or not, it was revived during the housing bubble of the late 2000s to warn of an overvalued market and the possibility of a collapse, which it eventually did.

The term could have been applied to the steady rise in crude oil prices following that financial crisis despite US oil production increasing to average 9.2m bbls/day in 2015, 9.5m bbls/day in 2016 and 9.6m bbls/year a year later, according to data from the US Energy Information Administration (EIA).

Even the International Energy Agency (IEA) recently suggested that the oversupply shows no signs of slowing down.

Heading into this year’s American Fuel and Petrochemical Manufacturing Association (AFPM) Annual Meeting, the euphoria from year’s past will be tamed and discussions will focus on the industry’s ability to adapt by reducing capital expenditures and finding a more cost-efficient way to improve productivity.

History repeats itself
Throughout history, crude oil prices have experienced periods of bubbles and crashes during which demand and supply were influenced by growth or geopolitical issues, and the industry had to respond accordingly.

In the early 1970s, the Organization of Petroleum Exporting Countries (OPEC) was established and the group, led mainly by Saudi Arabia, created the first supply shock before attempting to become swing producers. By opening or closing the faucet, Saudi Arabia, with the largest spare capacity, recalibrated supplies in order to maintain prices at a certain level.

In the mid-1980s, consuming countries attempted to reduce or slow demand growth and the crash, in response to bearish market sentiment, sent prices down into the teens.

There are two widely recognised crude oil benchmarks – Brent and West Texas Intermediate (WTI).

In 2008, WTI hit an all-time high of $147.00/bbl as the theory of “peak-oil” gained popularity as global crude supplies were declining. But, a few years later, prices plunged to $33.00/bbl as the financial crisis took a toll on demand.  By 2011, however, the benchmark was back up above $100.00/bbl, and various reputable forecasters were even suggesting a $200.00/bbl peak.

Led by US innovation, the so-called unconventional shale revolution that involved horizontal drilling and fracking rocked oil and natural gas production, leading North America to, if not energy independence, at least to energy security by cutting foreign imports. This led to a round of congratulatory “high fives” and victory laps, but then came the wake-up call as the industry started getting ahead of reality.

Then, the eurozone economic miracle developed serious cracks and the meteoric growth of China’s economy was showing signs of heading for a hard landing. Amid oil production so high that demand could not keep up, crude oil prices plummeted through the end of 2014 and into January, decreasing by more than half.

Passing the mantle
Much has been said about OPEC’s – or OPEC’s more wealthy producers in the Arabian Gulf led by Saudi Arabia – decision late November 2014 to leave output quotas unchanged. Saudi Arabia in particular chose to relinquish the role of global swing producer and defend market share.  

In essence, the mantle of “swing producer” was passed to the US. The strategy was to drive prices down and discourage investment, especially in unconventional wells and force producers to cut back until demand recovers.

Going through a panic phase and uncertainty about prices bottoming out, the US oil industry started to lose its shine, and investors walked away.

Oil companies have been forced to recalibrate capital expenditures, become more efficient, adapt and improve productivity in order to survive the downturn. A number of companies have filed for bankruptcy, and mergers and/or acquisitions are being projected.

Despite that, in February, the IEA admitted that the US will remain the main source of global oil supply growth for years to come.

Meanwhile, the US economy has managed to rebound and, the dollar, which had been declared “dead” by many experts, has made a serious recovery.

According to the EIA, refinery runs have averaged over 16m bbls/day, with foreign imports (mainly from Canada, Mexico and Saudi Arabia) at about 7m bbl/day to satisfy the imbalance. Refined products demand has been at around 18m bbl/day to cover domestic requirements and export sales.

As the US Federal Reserve wound down its bond buying program, the European Central Bank initiated one and China’s banks have attempted to inject stimulus into their economy.

Market participants have been keeping an eye on negotiations between Western powers and Iran for signs of progress over the nuclear programme that could result in the lifting of sanctions and an increase in oil exports from the Middle Eastern country.

The weekly Baker Hughes survey showing a substantial decline in the number of drilling rigs has become an indicator of crude oil output that also gauges market sentiment.

Timing the recovery
A few weeks ago, however, it seemed as if the Saudi strategy was paying off, with WTI rising above $50.00/bbl and Brent spiking above $60.00/bbl.

Saudi Arabia responded by raising its official selling price to long-term buyers of their oil.

But, Dan Lippe of Petral Consulting was quick to remark, “I think the current rally will be short-lived. All the bearish factors remain in place, and US production will continue to increase.”

During the week prior to AFPM, bearish sentiment prevailed and both Brent and WTI hit lower lows – Brent, the low $50.00s and WTI the low $40.00s.

In a recent article, James Ray, Senior Consultant at ICIS, concluded: “Historical recoveries from price drops of lesser magnitude have taken 12 to 35 months to return to the original trend line price level. Considering the average rate of historical and assuming no other major changes in the economy or product demand growth as a result of a geopolitical crisis, we can, in theory, better predict this recovery to be longer due to the larger-than-usual drop in price this time. This would indicate that we would reach $100/bbl in Q4 of 2017. This is a 35-month recovery that is consistent with longer past recoveries. “

During the 1980s crash, a bumper sticker was seen on cars around the Houston area: “Please God give us another oil boom. We promise we won’t piss it away this time.” 

The jury is still out.

The AFPM Annual Meeting takes place 22-24 March in San Antonio, Texas.