3. Strategic analysis
3.3 The Oil Price – Historical perspective
The balance between supply and demand for oil is what drives the oil price, and the most important factor for demand is, as already mentioned, the growth in GDP. The global GDP growth is primarily driven by the development in Brazil, Russia, India and China (BRIC-countries). In the aftermath of the financial crises and the Eurozone crisis, the volatility of the oil price has dramatically increased.
More production in relation to demand for oil is considered to be one of the main reasons the oil price has fallen over 50% from ~100 USD/bbl. to ~50 USD/bbl.
The organization of oil exporting countries (OPEC) have since 1960 worked as a cartel that controls the supply for oil from several oil producing countries in order to stabilize the price at a profitable and sustainable level. By cutting oil production and decreasing the volume made available to the market, the organization led by the world’s biggest oil producing country, Saudi Arabia, has managed to establish a price level that normally lies over the break-even-levels of oil production.
Figure 18: Historical development of Brent – yearly average price
Source: statista.com, wtrg.com and Wikipedia.com
The development of extracting shale oil stands as a threat to the general offshore activity and the OSV industry. Fracking of shale oil in the US, and Canadian oil sand extraction began to change the dynamics of the oil and gas market. Thus, offshore drilling (due to its high complexity, long lead-times, and high upfront cash investments) is now losing out on capital allocation. Shale oil, many argues, is one of the reasons for the steep decline in oil price the last couple of years, which
33 International Monetary Fund. (Jan. 19, 2016). World Economic Outlook.
'14-'16: Non-OPEC high production and lower demand leads to another crash from 99,03
to 41,67less than two years '08-'09: Financial
recession, brent collapses from96,99
to 61,51in a year
54,38 - '05-'08:
Steady increased demand from … 25,01- '00:
Middle-east output uncertainties due to
9/11 increase price
17,9 -'99: Demand recovers after Asian debt crisis, and production cuts 23,8 -'90: Kuwait cuts production as Saddam invades the country
15 -'88: Peace between Iraq …
14,4- '86: SA increase production 36,8 -'80: Middle-east
turmoil decrease export from the region
31,6- 78.79: Iran halts production and
export
0 20 40 60 80 100 120
1976 1981 1986 1991 1996 2001 2006 2011 2016
USD/bbl.
Year
31 has shifted the supply and demand balance significantly.34 Furthermore, as shale oil production continued to climb, OPEC decided not to change their production volumes. The oil price crashed as a result, and all industry-related parties started to creep below break-even levels.
Countries in the middle-east, specifically Saudi Arabia, could ride out low oil prices due to cheap production, while shale oil production was still in its infancy and more expensive to extract.
However, the effects were also felt by companies and regions operating with higher OPEX and CAPEX such as the Norwegian OSV-operators.35 Another factor is that China’s unprecedented growth during the last couple of decades has begun to slowly flat out which in turn has reduced their demand for oil. Thus, in this scenario any recovery for deepwater would be multiple years out, while short-cycle projects such as U.S. shale oil could benefit sooner.36 Figure 18 depict how the price of Brent oil has been affected by a selection of events since 1976 to the end of the first quarter of 2016
3.3.1 Oil supply and demand
According to numbers from the American Energy Administration, EIA, the global oil production in 2015 averaged out at around ~96-mill b/d, against a consumption of ~94 mill b/d. Among non-OPEC producers outside of the U.S., the largest declines in production are forecasted to be in the North Sea. After an increase in 2015, production in the North Sea is expected to return to its long-term declining trend in 2016 and 2017, as the plans to start of several projects is not enough to offset the region’s declining rates37.
Furthermore, in light of the recent cutbacks in E&P spending, there is a consensus view that there will be a reduction in global oil production.
Particularly in U.S. Shale, where depletion rates are high and production growth is likely to respond rapidly.38
Global offshore oil production is forecast to reach 26m-23m b/d in
34 Fearnley. (April 2016). The Offshore Report.
35 The Economist. (December 14, 2014). Why the oil price is falling.
36 DnB Markets. (April 2016). Oil Services - More tough years ahead.
37 U.S. Energy Information Administration. (March 2016). Short-Term Energy Outlook
38 DnB Markets. (April 2016). Oil Services - More tough years ahead.
Figure 19: Offshore oil and gas production ’86-16F
Source: Clarkson Research “OSV monthly” April, 2016
32 2016, a YoY increase of 1,2%. However, offshore oil production is forecast to decline in North West Europe, Mediterranean, the Middle East and Asia Pacific, mainly due to natural output reductions from maturing fields located within these regions, and a move towards gas production.
The average storage of oil at 0,76 MM/bbl./day the last year and the expectation that there will be continuous over production, has led to high uncertainty in the price forecast and drastic fall in the spot price of Brent and WTI crude oil. Global oil inventories are forecast to increase by an annual average of 1,6 million b/d in 2016 and by an additional 0,6 b/d in 2017. These inventory buildups are larger than previously expected, delaying the rebalancing of the oil market and contributing to lower forecasted oil price. However, the market seems to be adjusting and gradually balancing out according to analysts.39
U.S. oil stockpiles has shown to be a significant influence on WTI crude oil. Figure 20 illustrates how an increase in oil inventories has negatively affected the USD per barrel since 2012 to 2016.
The market’s expectations about change in US oil inventories is a catalyst that somewhat drive crude oil price. If inventories increase more than expected the market believes that there is a weaker demand and the price becomes bearish. On the other hand, if the increase of stockpiles is less than expected the market believes that there is a greater demand and the oil price becomes bullish.40
The reduction in the oil price the past year and the expected low levels in the future has an indirect effect on the growth and activity in the world economy. Oil exporting countries such as Norway, Russia and emerging markets is experiencing drastic reduction in their fiscal income. This leads to a readjustment downwards in GDP growth. Oil importing countries on the other hand, will have the
39 British Petroleum. (2016). Energy Outlook 2016.
40 http://www.investing.com/economic-calendar/eia-crude-oil-inventories-75 Figure 20: WTI crude oil price development against US oil stockpiles, 2012-2016
Source: U.S. Energy Information Administration, April 13th-, 2012-2016 weekly reports 0
100 200 300 400 500 600
0 20 40 60 80 100 120
13.04.2012 13.04.2013 13.04.2014 13.04.2015 13.04.2016
US Stocks (mBarrels) WTI Crude Oil $/bbl
Lineær ( US Stocks (mBarrels)) Lineær (WTI Crude Oil $/bbl)
33 possibility of increasing their public investment with savings from lower energy subsidies. The International Monetary Fund (IMF) confirms that a lower oil price could help the global growth, as the consumer will have greater economic flexibility to use for personal goods.41 GDP growth through increased consumer confidence and increased disposable income could boost activity and thus energy demand. Despite the positive effects for oil importing countries, it is only expected a gradual improvement in the world economy in 2016 and 2017 at 2,9% and 3,1% respectively as observed from table 3.42 As explained earlier, China has experienced weak GDP-growth the last couple of years as a result of investment reductions. Nevertheless, the low oil price has led China to take over the spot as the world’s largest net importer of oil with a daily import of 7m/bbl./day, while the U.S has become less dependent on oil imports due to domestic production opportunities.
3.3.2 Forecast of the oil price
Due to high uncertainty in market equilibrium and the number of high volatility factors affecting the market conditions it is difficult to give a reasonable estimate for the future oil price. By combining fundamental expert analysis with pricing of oil futures it is possible however to form a picture of how the market will most likely develop in the near future. The longer the forecast horizon, the more difficult, imprecise and uncertain predictions become.
Figure 21: Forecasted oil prices, 2016-2017E
Source: EIA 2012-2016 petroleum reports
The oil price levels for both Brent crude oil and WTI are expected to average the same at $34/bbl.
in 2016 and $40/bbl. in 2017 which is a reduction of USD 3/bbl. and USD 10/bbl. from the previous forecast done by EIA. A decrease in forecast prices, according to EIA, reflects an oil production that has been more resilient than expected in a low-price environment and lower expectations to forecasted oil demand growth.43 Figure 21 shows the different future contracts that extend through
41 International Monetary Fund. (Jan. 19, 2016). World Economic Outlook
42 World Bank Group. (Jan. 2016). Global Economic Prospects.
43 U.S. Energy Information Administration. (March 2016). Short-Term Energy Outlook.
20 40 60 80 100 120 140
2012 2013 2014 2015 2016 2017E
$/bbl
West Texas Intermediate Spot Average Brent Spot Average
WTI Forecast Brent Forecast
34 2017 with an expected oil price of around $40/bbl. Overproduction and lower expectations for global economic growth contributes to a reduction in the oil demand forecast. Inventory buildup in the U.S. and OPEC, due to still being resilient in maintaining market share, puts additional short-term pressure on the oil price. Yet, expansive monetary policy in Europe, stable (albeit slower) growth in China and indirect easing of cheaper oil, could in the future open for higher oil demand in the medium - to long-term. There is however, a high uncertainty in the futures contracts for oil price. This is illustrated by the market expectations of WTI crude oil where the price in December 2016 ranges from $20/bbl. to $81/bbl. with a 95% confidence interval, and the implied volatility averaged 50%. High forecast inventory and slower market rebalancing contributes to a more limited price recovery than earlier anticipated. The expectation of reduced cash flows in 2016 and 2017 has prompted many companies to scale back investment programs, and deferring major new undertakings until a sustained price recovery is displayed.44 The development in shale oil combined with lower growth in oil demand stands as a threat to the general offshore activity level and the OSV-industry. We thus set, through the fundamental analysis, an oil price in the short- to medium-term at $45/bbl. and in the long-medium-term a (optimistic) balancing out for both Brent and WTI of approximately $60/bbl., which is believed to be the consensus of many analysts.45 It is further noted that a stable oil price at $60/bbl.+ is required for the deep-water cycle to reach the threshold for recovery, and operate at favorable rates.46
3.3.3 Geopolitical risk and random shocks
Geopolitical risk and random shocks, so-called “black swans”, can have significant impact on the oil price. In order to understand the whole picture, it is necessary to explore how major events affect the global economy and how they in turn affect demand in the short- to long-term. One contributor to the high uncertainty in the oil price is the political tension in Middle East, concerning both terrorism groups like ISIS and political tensions. Early in 2016, the sanctioned Iranian oil re-entered the market, triggered by Tehran’s compliance with nuclear agreement.47 Iran’s finance minister described the current oil price as representing “an all-out war” for market share. As a result, the returning Iranian oil will arrive in an already fully saturated market at a time of maximum seasonal weakness. However, if the volume turns out be lower than anticipated, the market would have a reason to moderate their muted outlook. Another question that now lingers and haunts the oil market is whether China is transitioning from an industrial economy to a consumer and service-oriented
44 U.S. Energy Information Administration. (March 2016). Short-Term Energy Outlook.
45 DnB Markets, EIA, IMF
46 DnB Markets. (April 2016). Oil Services - More tough years ahead.
47 Financial Times. (Jan. 2016). Oil price are at the mercy of geopolitics.
35 economy, or if there are deeper structural problems that indicate slower growth and more uncertainty of the kind recently seen in the Chinese stock market.
The steady stream of negative developments is contributing to a reinforced sentiment that weighs down the oil price. In combination with fear among some, that the global industry can run out of places to store the surplus, the tension and uncertainty in the oil price is as prevalent as ever.
3.3.4 Oil price summary
Keywords
Price volatility, but increased trade.
Crude oil price expected to rise, albeit slowly
Reduction in supply
Larger-than-expected rise in both U.S. industrial production and existing home sales in January along with continued gains in U.S. employment supported crude and equity market
Market adjusting and gradually rebalance that will take several years to fully stabilize.
Oil price estimated to $45/bbl. short-to-mid-term (2016-2018)
Long-term (2020-) we can expect a gradual bounce-back with oil price above $60/bbl.
In short
Despite a positive development in the oil price at the beginning of 2016, the market struggles to be optimistic about the offshore focused service industry, as analysts believe a recovery in backlog build and earnings is several years off. Furthermore, as mentioned, deepwater would be the last to benefit in a recovery situation and that sustainable recovery in the deepwater development cycle is several years’ way. In order for deepwater to regain its competitiveness, costs would have to come down significantly – and permanently. The flipside is that the addressable deepwater market should be structurally lower in the next cycle. Deepwater development costs have fallen significantly, but other oil sources have seen similar – if not greater – cost deflation. Finally, DnB Markets still find it unlikely that deepwater market will dry up completely, but expect an “air-pocket” of demand towards end of the decade due to long lead-times.48