energy: oil

history

–oil began replacing coal as fuel of choice in the early 20th century, but that loss was mostly offset by substitution of coal for wood, until…

…at the end of WWII, Saudi Arabia, having lost its primary source of revenue, Hajj pilgrims, in the prior decade-plus, opened its oil deposits to foreign development.  

–Third-world producing countries formed OPEC in 1960 as a political organization to battle exploitation by oil-consuming countries.  In the 1970s, OPEC “shocked” the world by raising the price of crude oil in two stages from $1 barrel to $7.  In the panic that ensued after the second increase the price spiked to over $30 before collapsing and staying low for years.

–During the 1970s oil crisis, every major consuming nation other than the US acted decisively to decrease dependence on oil.  If anything, the US did the opposite.  One result of our misguided policy (to protect domestic auto firms) has been that although the US represents 6% of the world’s population it consumes 20% of global oil output.  Another, despite this + trade protection of domestic carmakers, has been loss of half the domestic auto market to better-made, more fuel-efficient imports.  (In most cases this is what happens–protection weakens the protected sector.)

supply/demand

price dynamics

Pre-pandemic, the world was producing about 100 million barrels of oil daily.  It consumed about the same.  Oil supply is relatively inflexible.  In over-simple terms, once a large underground pool of oil start to flow toward a well, it’s difficult to stop without harming its ability to start up again.  Because of this, even small supply excesses and shortfalls can induce sharp price changes.

supply

The biggest oil producers are:

US          19.5 million barrels/day (includes natural gas liquids.  crude alone = 12.7 million)

Saudi Arabia          12 million

Russia          11.5 million

Canada, China, UAE, Iraq, Iran      each 4 – 5 million

demand

The biggest oil consuming countries are:

US          20 million barrels/day

EU          15 million

China          13.5 million

India, Japan, Russia      each about 4 million

my stab at production costs (which is at least directionally correct)

Saudi Arabia        less than $5/barrel

Russia          $30/barrel

US fracking          $40/barrel

where we stand toady

The coronavirus outbreak appears to have reduced world oil demand by about 15 million barrels a day.  Enough surplus oil is building up that global storage capacity will soon be completely full.  Also, a spat broke out between Saudi Arabia and Russia over production cutbacks to support prices.  When the two couldn’t agree, the Saudis began to dump extra oil on the market.

West Texas Intermediate, which closed last year just above $60 a barrel, plunged to just above $20 a barrel in late March.  It goes for about $24 as I’m writing this late Sunday night, despite Moscow and Riyadh seemingly paving patched up their differences last week and agreeing to cut their output by 10 million barrels between them.  The market was not impresses, as the Friday WTI quote shows.

fracking

The US is in a peculiar position:

–the administration in Washington appears to have two conflicting energy goals:  to keep use of fossil fuels as high as possible; and to keep the world oil price high enough to make fracking profitable.  The first argues for lower prices, the second for higher.

–according to the Energy Information Administration, fracking accounted for 7.7 million barrels of daily crude oil liftings in the US last year, or 63% of the national crude total.   If the cost numbers above are anywhere near accurate, domestic frackers are in deep trouble at today’s oil price  

This doesn’t mean production will come to a screeching halt. 

The industry has two problems:  excessive debt and high total costs.  According to the Wall Street Journal, Whiting Petroleum, a fracker who recently declared bankruptcy, prepared for pulling the plug by drawing its full $600 million credit line, swapping stock in the reorganized company to retire $2 billion in junk bonds and paying top executives a total of $14.5 million.  That solves problem number one. 

As to number two, total costs break out into capital costs (leases, drilling…) and operating costs.  I have no idea what the split is for Whiting and I have no interest in trying to figure it out.  My guess is that the company can generate positive cash flow even at today’s prices.  Almost certainly the reorganized company can.  It may choose to shut its existing wells in the hope of higher prices down the road.  But it could equally well opt to continue to operate just to keep experienced crews together.  However, new field development is likely off the table for now.

my take

When I was an oil analyst almost (gulp!) a generation ago, the ground level misunderstanding the investment world had about OPEC was the belief that it was an economic organization, a cartel, not the political entity that it actually was.  The difference?–economic cartels invariably fail as members cheat on quotas; political groups have much more solidarity.  Today’s OPEC, I think, is much more an economic cartel than previously.  In other words, it can no longer control prices.  And despite the fact that Putin and MSB have extraordinary sway over the administration in Washington, my guess is this won’t help, either.

There’s some risk that investing in oil today is like investing in firewood in 1900 or coal in 1960.

Despite this, for experts in smaller US oil exploration companies, I think there will be a lot of money to be made after a possible wave of bankruptcies has crested.  Personally, I’d rather be making videos.

 

 

 

 

 

 

 

 

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