“Today’s low prices will encourage consumption”
Today’s global oil market collapse is eerily reminiscent of the dot com crash of 2000. Like the 1995-99 hype accompanying the rise in internet stocks, over the last several years there has been enormous promotion of the “game changing” unconventional technologies used to develop North American shale and oil sands reserves. Following their huge run-up, both high technology and North American oil and gas stocks experienced implosions – the high tech NASDAQ composite index fell 78-percent from the peak in 2000, and in the past six months, the S&P/TSX Oil and Gas Producers Index has fallen about 35 percent.
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There is widespread coverage of layoffs in the oil patches of Alberta, Texas and North Dakota. The Alberta government is warning of looming deficits and tough choices ahead. Many investors have concluded that low-cost Saudi Arabia has launched a market share war it is sure to win against high-cost North American unconventional production.
A recent report from the International Energy Agency (IEA) adds a much needed perspective to the debate. According to the IEA, the North American unconventional oil business in general and Canada’s oil sands in particular will emerge from today’s unrest larger and stronger. To understand why, let’s examine the demand and supply dynamics of the oil market. In 2014, global oil and natural gas liquids demand was about 92.4 million barrels per day, having grown by about 1.0 million barrels per day each of the last 4 years while prices averaged about $100 per barrel.
However, supply over the last year or so began growing faster than 1.0 million barrels per year, oversupplying the market and ultimately leading to the recent fall in prices (about 50%) as the market tried to find equilibrium. The IEA’s report tells us that today’s low prices will encourage consumption – drivers will take longer trips and buy bigger vehicles, for example – increasing demand by around 1.1 million barrels per year to reach about 100 million barrels per day in five or six years (around 2020).
In the short term, there is likely going to be limited supply growth due to today’s low prices around $50 per barrel. Therefore, the global market, which is oversupplied about 1.5 million barrels per day, should be back in equilibrium in about 1.5 years or less – a blink of an eye considering North America has several decades’ worth of reserves at current production rates.
The question should not be whether the energy business will recover, but how will that 100 million barrels per day of demand by 2020 be supplied? Based on analysis by the IEA, Saudi Arabia has kept its share of global supply roughly the same at about 11 percent for more than 10 years and has made it very clear it is not looking to increase production. Almost all other members of OPEC (Organization of the Petroleum Exporting Countries) have already been producing close to capacity and their share of global supply has stayed fixed for 10 years at approximately 29 percent.
OPEC is not likely to supply more than 40 percent of the world’s demand and Russia’s share of global production is expected to fall to about 10 percent of global supply. Together, in coming years, they are not likely to produce more than about half of the world’s oil. North America is not wrestling for market share against these strong producers.
Meanwhile over the last 10 years, the U.S. and Canada’s market share of global supply has jumped from 4 percent and 10 percent, respectively, to 5 percent and 15 percent, capturing market share from an eclectic mix of countries across Latin America, Europe, and Asia, also known as the Rest of the World (“ROW”).
All of North America’s growth has come at the expense of ROW, which has seen its share over the last 10 years fall from 35 percent to 29 percent as a result of factors like poor geology, unfriendly fiscal regimes, lax rule of law and resources owned by slow-moving governments (there are a few exceptions, such as off-shore Brazil). North America is facing a winning battle for market share against the feeble ROW.
The IEA is forecasting that by 2020, North America will have increased production from today a further 3.0 million barrels (20 percent) and be producing about 19 million barrels per day.
Both the IEA and the futures market are currently pricing oil in 2020 at $73 per barrel. At that price, the North American energy industry will be earning revenue of about $1.4-billion per day in 2020 – comparable to the $1.5-billion per day in 2013 when oil was $100 per barrel. With costs lower, returns will remain attractive at $73 per barrel.
In the future, we will look back at today and realize that, like the internet in 2000, the North American unconventional oil business today is just taking a breather before moving on to scale greater heights. Get set for the next oil boom.
Adam Waterous is Co-Head of Equity and Advisory at Scotiabank Global Banking & Markets, which includes Scotia Waterous, the company’s oil and gas mergers and acquisitions division.
