Amid talk of “super-spikes” and shortages – are we near peak oil bullishness?

published 9 July 2018

20180709-Aramco-634 — Amin Nasser: beware the coming supply crunch

The chief executive of Saudi Arabia's state-owned oil giant, Saudi Aramco, has warned of an upcoming oil supply crunch.

Gosh, you might think, there's a surprise. "Man who is trying to sell a massive oil company for a huge amount of money claims that we're running out of oil." As headlines go, it's right up there with "Estate agents say temporary dip in house prices is a great buying opportunity."

But let's not be too cynical. The oil market has become rather more interesting in recent months. It can't quite seem to work out whether it's coming or going.

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So what's going on?

Oil companies aren't exploring for big finds' anymore

Amin Nasser is the chief executive of Saudi Aramco. In an interview with the Financial Times, he argues that US shale oil can't meet global demand alone.

His point is that shareholder-owned oil companies around the world have pulled back from investing big sums in long-term mega-projects. Instead, they'd rather put money into shorter-term, less risky things, such as shale fields, where they can unlock the oil - and thus the cashflow - a lot faster.

Clearly, Nasser - as the manager of Saudi Arabia's fields, the very definition of a long-term mega-project - has his own drum to bang here. But he's not the only one concerned about long-term investment.

The International Energy Agency, says the FT, notes that a lack of investment in "new large-scale projects will lead to a supply shortfall in the early 2020s just as US shale production plateaus."

Meanwhile, one US analyst (Bernstein Research, if you care) warned that oil prices could "super-spike" to more than $150 a barrel as a direct result of this lack of investment.

Bernstein notes that 15 companies account for 80% of the world's oil reserves. Only two of them are investing anything like enough money in more production. The industry's re-investment ratio (cash flow vs investment in exploration and production) is at its lowest level "in a generation."

Big companies had 15 years worth of reserves left in 2000. Now that's down to just ten years.

If oil demand peaks before 2030 due to electric cars and renewables and the like then everything will be fine. Oil companies will be proved right and their drive to become part-renewable companies will have paid off.

Yet as CNBC notes, quoting Bernstein's somewhat breathless note, if the alternatives don't work out, and a lack of investment leaves us short of oil, then clearly, we can expect higher prices. "Any shortfall in supply will result in a super-spike in prices, potentially much larger than the $150 per barrel spike witnessed in 2008."

Are you getting deja vu here? I mean, I swear that it's only three years ago that everyone was talking about how we'd have to leave all the oil in the ground because we were going to end up with fully electric cars anyway. We were hitting "peak oil demand".

And in the oil boom before that, it was all about "peak oil supply" and how we were genuinely running out of oil. I remember, near the start of my career, writing earnest pieces explaining the mechanics of "peak oil", and how it kicked in once you'd got to the "hard-to-reach" bit of the oil well.

I mean, it's almost as if the price dictates the narrative rather than the other way around.

The frustratingly predictability of resources cycles

That of course, is exactly what happens. At a very basic level, the facts do impact on the price. The "fact" of US shale oil eventually triggered the 2014 drop in oil prices. But the "narrative" the popular story attached to those facts, and the epic extrapolations that this creates is entirely dictated by prices.

This is what makes commodity cycles and oil in particular endlessly fascinating to watch. And also very frustrating.

On the one hand, they are spectacularly predictable, because the basic business hasn't changed much. Oil prices are high. So producers produce too much oil. The oil price goes down. They cut production. The oil price keeps going down.

The producers swear they will never pump another barrel again. The bumper stickers appear all over Texas and Dakota "Lord grant me one more boom and I promise not to screw it up".

The leftover oil runs out. So the price starts to go up.

Producers start producing again. The price keeps going up. Producers start exploring again. They find the most expensive corners of the world possible and funnel money into grandiose projects, because there is simply no oil left in the world. They produce too much oil.

Go back to the start, repeat ad nauseam (or until broke).

So it's like a pendulum. And at either end of the pendulum's arc, comes the point where people most fervently believe that the pendulum simply will not swing back this time. "Peak oil supply" at one end, "peak oil demand" at the other. Extrapolation goes wild. It's beautiful to watch.

However, for all that the shape of the cycle is utterly predictable, the timing of the turns is much harder. It's like watching a James Bond or a superhero film. You know exactly which plot points the film has to hit, but you can't be quite sure how long it'll take between turning points, or which individual twists this particular film will take.

So where are we now?

Mood in the oil market has clearly shifted. People are now questioning the ability of both shale and Saudi to cap the oil price in the face of collapsing Venezuelan production and the return of Iran to pariah status. Eye-catching calls for "super-spikes" are also often associated with over-optimistic sentiment. (The 2008 oil boom saw calls for $200 oil.)

That said, judged on "feels" alone, I don't think the pendulum has swung far enough towards the "pump all the oil you can!" end of its arc. So if you've invested in oil, you can hang on for now, I reckon.

Meanwhile, the lack of investment in oil exploration does suggest that if you're interested in investing in the sector, then the oil services companies may still offer potential opportunities.

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.