Opinion

The Trends That Will Be Driving the Oil Price in 2016 (and Beyond…)

Posted by Andreas de Vries

12-Dec-2016


The past 18 months have been especially tough for those in the business of forecasting the crude oil price.

At the end 2013, when Brent closed at $112 per barrel and WTI at $100, the investment banks expected crude to continue to price around $100 per barrel during 2014. In actuality, of course, the price dropped to below $60 per barrel that year, as the market became oversupplied and OPEC refused to cut its production to rebalance supply and demand.

For 2015 essentially everyone got it wrong again. At the start of that year the general expectation was that at around $60 per barrel, the price was (close to) bottoming out, since a substantial amount of the North-America unconventional production (US shale and Canadian tarsands) had become uneconomical and would thus be removed from the market shortly. But, as US shale production did not go down nearly as much as expected, the price decline that started in 2014 did not bottom out but kept on going. During December 2015 Brent eventually reached an 11-year low of $34 per barrel.

How could the forecasts have gotten it so wrong?

A major factor was the human tendency to assume that the trends we presently experience, the trends that drive our world today, will continue into the future. In other words, that fundamentally everything will stay the same.

For example the 2015 crude oil price forecast foresaw a reduction in US shale production because it assumed these barrels would continue to cost between $70 and $90 to produce, as they did when OPEC's “War on Shale” began in 2014. What really happened, however, was that the shale producers aggressively drove improvements and efficiencies in all elements of their value chain. New reservoir analysis techniques and well completion improvements have enabled the producers to increase average initial production of newly drilled wells (as compared to wells drilled earlier in the Shale Revolution), while refracking has proven to be a (partial) solution for the shale wells' notorious decline rate. Furthermore, the introduction of pad drilling has reduced the overall time needed for drilling while extending the reach of horizontal wells, thus lowering development costs. This has enabled the US shale industry to drastically lower production costs (by as much as 65% according to some estimates), maintain 2014 production levels throughout most of 2015, and even prepare for a possible future uptick in prices through maintaining DUCs (drilled but uncompleted wells) capable of adding some 500.000 barrels per day to production.

This lesson in this little bit of recent crude oil price forecasting history is that forecasting requires more than extrapolation of the current trends in the industry today. It requires identification of coming trends that will drive the industry tomorrow.

In this regard, crude oil price forecasters should take note of the research done by Ray Kurzweil into the nature of technological innovation. Kurzweil is one of America's leading inventors and futurists and currently Google's Director for Engineering. For his book “Singularity is Near” he researched different sciences and technologies – computers, memory, DNA sequencing, communication, internet – to find that innovation does not proceed in a constant manner. Rather, it tends to accelerate. The more we learn, the easier it becomes to learn even more, and the faster we will learn even more.

If Kurzweil's Law of accelerating innovation were to hold in the oil & gas industry as well, what new trends would this lead to in the future?

Firstly, it would mean that shale technology goes global, substantially increasing both shale production and proved (technologically and economically recoverable) reserves. Continued innovation in shale technology will namely address the key pain points of shale oil and gas production, i.e. its cost and environmental impact, opening the way for development of the contingent resources located in places such as China, Russia, Argentina, Europe and the United Arab Emirates. A lot of these improvements are already underway, in fact. For example, centralized rather than well-by-well wastewater management is being studied to lower shale's operational costs and environmental footprint and waterless fracking is being researched to eliminate the issue completely.

Secondly, it would mean shale technology becomes a quaternary recovery technique, increasing crude oil production and expected ultimate recovery rates for mature oilfields around the world. Tests on a number of mature oilfields in North America have already shown that the techniques behind shale, horizontal drilling and hydraulic fracturing, can indeed achieve this, not only through developing tight zones in these fields that were left behind during original development, but also through re-stimulation. The cutting edge of these technologies is currently being tested on the giant mature conventional oilfields of the Middle East.

These two new trends will, in turn, lead in a third new trend: decoupling of the crude oil price from political events. If, namely, shale technology goes global and becomes a quaternary recovery technique for mature conventional fields, global crude oil production capacity will not only be increased but also diversified, reducing the influence of individual countries over production and transportation. The current global crude oil market is characterized by concentrated production with just 10 countries being responsible for two thirds of global crude oil production, five of whom are located in the greater Middle East. At the same time the top 10 consumers of crude oil also make up close to 60% of global consumption. This leads to transportation chokepoints and a relatively small number of countries having substantial leverage over the global crude oil supply and demand balance. Diversification of production will reduce the importance of these countries for the global crude oil supply and demand balance, thus making the crude oil price less susceptible to political events in these countries. This trend can be witnessed already as well, for example in the relatively muted response of the crude oil price to events such as the Syrian Revolution, the rise of ISIL in Iraq, and most recently the tensions between Saudi-Arabia and Iran.

Andreas de Vries is a Strategy Consultant in the Oil & Gas industry, supporting companies to formulate strategies for success and translate them into concrete action and practical results.

Market Analysisoil price

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