Triple Digit Oil Prices: Are You Ready?

Energy
  • Rystad Energy stated that global conventional oil and gas discoveries reached an all-time low in 2017. We estimate that global oil and gas industry only found four billion barrels of new conventional oil last year that capped a dismal 20-year stretch for conventional oil discoveries
  • Since the start of the shale oil revolution in 2007, discoveries of conventional oil have totaled 110bn barrels while consumption has totaled 360bn barrels. Thus between 2007 and today, we have consumed 250bn more barrels than we have replaced through conventional discoveries
  • Based on our analysis, we concluded that except for three shale basins (the LaLuna shale in Columbia, the Vacua Murte shale in Argentina, and the Bashenov shale in Russia), the shale oil revolution will not be exportable to the rest of the world
  • Consensus opinion has significantly overestimated the ultimate recovery of oil from US shale plays. Our analysis indicates that both the Bakken and Eagle Ford shale play will recover somewhere between 3 and 4bn barrels of oil each. Niobrara should recover ~1.5bn barrels of reserves. We believe the Permian will recover 20bn barrels. 3bn barrels will ultimately be recovered from SCOOP/STACK. Adding up the total recoverable reserves from these five plays, we believe that ~30-35bn barrels will be recovered from the US shales
    • Adding this to the conventional discoveries discussed above, the world has still consumed 215-220bn barrels more than it has discovered over the last 10 years
  • Investors have erroneously attributed an almost limitless amount of reserves and production capability to the shales. More and more evidence has emerged suggesting drilling productivity in the shales is peaking and may very well start to decline – especially in the Eagle Ford and Bakken
  • Permian and SCOOP/STACK will continue to grow strongly over the next several years, however with 2 of the major shale plays now in decline, it will be very difficult to replicate the back-to-back 1.5mmb/d annual production growth experienced in the US in 2013 and 2014 – a time when Bakken, Eagle Ford, Niobrara, and Permian were all simultaneously ramping up production

Oil Markets

  • Despite all the bearish commentary throughout 2017, WTI and Brent advanced 12% and 18% for all of 2017
  • Bearish sentiment did express itself however in the underlying energy names. S&P Oil and Gas company index (XOP) rose only 9.3% and Philadelphia Oil Service index (OSX) rose only 5% during the quarter – this lagged the sharp 4th quarter rise in oil prices
  • Research continues to tell us that triple-digit oil prices are a high-probability event as 2018 progresses. Because of their underperformance last year, believe oil-related investments have presented investors with a tremendous buying opportunity
  • After a rocky start in January and February of last year, inventories began drawing substantially, and these draws continue today. From the end of February until the end of October, total OECD crude and product inventories have drawn by nearly 150mm bbl compared with a 10-year average build of nearly 60mm bbl for that period
  • US core petroleum inventories today stand at 70m bbl above normal while OECD inventories stand at 200mm bbl above normal, 70% and 50% below their peaks and the lowest levels since 2015
  • When a country reaches a certain level of per-capita real GDP, oil demand starts to accelerate materially (S-Curve model). China has been the largest country to go through its S-Curve over the last 10 years, but our models tell us now India is beginning to enter its S-Curve as well
  • From a starting deficit of 650,000b/d in 2017, we expect global demand will grow by 1.6mb/d, while the US will grow production by 1.1mb/d and the rest of non-OPEC will contribute growth of 400,000b/d
    • Would leave the global crude markets once again in deficit by 750,000b/d for all of 2018
    • Global inventories would drop by another 250mmbbl from today’s levels, leaving inventories at dangerous 140mm bbl below the long-term average – the largest such deficit in our records
  • As inventories continue to draw, prices will continue to respond and could very easily reach $100/bbl as market psychology switches from worries about surplus to worries about deficits
  • “Many people ascribe the reason for this tepid US oil production growth to be cash flow or service company limitations, but I think its lack of remaining Tier 1 geologic-quality drilling locations in two major oil shale plays of the three major oil shale plays, the Eagle Ford and Bakken. Even in a constructive oil price environment, I expect the 2018 total US oil growth will be considerably less than the 1.2 million barrels per day to 1.4 million barrels per day that many people are predicting… But I think if you look from the 30,000-foot level at the Bakken and Eagle Ford overall, I would say that they are no longer the growth engines that they were 4 or 5 years ago, and that the majority of the Tier 1 quality locations have been drilled and there’s just not that many to go. And if you suddenly got to an old price environment that, let’s just say, turns out to be $70 WTI and you pump a lot of capital into the Bakken and Eagle Ford, the resulting production growth that you’re going to see from current levels in those asset, I predict is going to be disappointingly low. But, clearly, you’ll have individual wells from time to time that will be successful. So, you have to look at it from the macro view and not from an individual well view.” – Mark Papa

Is India Becoming the Next Major Source of Commodity Demand Growth?

  • Since 2000, natural resource investors have been fixated on China as the main source of demand growth. Over the last 18 years, China’s oil demand has grown by nearly 10mmb/d, representing 40% of total global demand growth in that period
  • Most famous demonstration of an S-Curve model occurred in South Korea between 1970 and today. Once a country hits a certain level of per capita real wealth (S-Curve Tipping Point), oil demand begins to rise very sharply
    • Between 1975 and 1985, South Korea doubled its real GDP per capita from $2,600 per person to $5,400 per person. Over the same period, per capita oil demand grew 67% from 2.9 barrels per person per year to 4.8 barrels per person per year
    • Over the next decade, real GDP per capita grew by 120% while per capita oil demand grew at twice that rate
  • Between 2001 and 2008, Chinese per capita oil demand growth quadrupled
  • While India does indeed face many challenges going forward, the bulk of the shortfall between India and China can be explained by India’s lower level of economic development
    • India today is only just reaching the same level of real per capita GDP growth that China reached in 2001, when China first crossed its S-Curve Tipping Point
    • Over the last decade, India per capita oil demand has grown by 0.03 barrels per year – the same rate as China between 1991-2001
    • In 2016, real per capita GDP averaged $1,900 while its oil demand was 1.2 barrels per person per year (similar to China in 2001 when China’s real GDP per capita averaged $1,900 and oil demand was 1.4 barrels per person per year)
  • If India has indeed crossed its tipping-point and, using China as a guide, then we should expect to see India grow its per capita oil demand by nearly 2 barrels per person per year over the next 15 years
    • This equates to 7 mmb/d of total oil demand growth over the decade or ~500,000b/d per year- 67% higher than the IEA estimated in its most recent medium-term energy outlook
  • In South Korea, urbanization stood at 40% of the population in 1970 while primary energy consumption per capita averaged 0.4 tonnes of oil equivalent and real GDP per capita averaged $1,800. Over the next 15 years, its population urbanized substantially and by 1987 with real GDP at $6,500 per person, ~65% of the population lived in cities. Over the same period, primary energy demand per capital skyrocketed by 253%
  • China followed a similar path. In 2000, with real per capita GDP of $1,800, 36% of its population lived in cities while 16 years later with real GDP per capita at $6,900, nearly 60% of the population was urbanized. Per capita energy demand grew by nearly 200% as the country urbanized
  • India sits where South Korea and China did in 1970 and 2000. With $1,900 of per capita income, 33% of its population is urban and total per capita primary energy consumption averages 0.35 tonnes of oil equivalent. Projections from the UN estimate that India could add 300 mm urban residents over the next 15 years which would equate to a ~50% urbanization rate by 2030
    • In turn, this would suggest that total primary energy consumption will need to grow by between 160% and 270%

Goehring & Rozencwajg Natural Resources Market Commentary 4Q17

Image Source: Wood Mackenzie, Goehring & Rozencwajg Models

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