The year 2017 has mostly been predicted as a year of recovery for the oil prices, since the OPEC, backed by Russia reached a deal in November 2016 to cut production. However, this year for the most part witnessed a showdown between OPEC and US shale, where the efforts by OPEC to reduce the global inventories are being challenged or even cancelled by the US shale revival.
In such a situation, the one question that occurs in our minds is – what do we expect ahead? Is the oil heading anywhere near the optimistic $70 dollar price as many predicted after the OPEC deal.
Actually, the more expedient and fruitful question that we should be asking is – where are we currently in the oil and gas price cycle.
Prevising the future in revising the past
It isn't an astonishment for any market trader/ investor in oil and gas that this business is cyclical. Prices shoot up when demand outpaces the supply, hover on the peak for a few years, then plummet with the development of new supply sources and the consequent slow down of the demand growth.
After the infamous 1986 collapse, oil prices were inconsistent through 1990, then tumbled around 1998 with the increase in production from the Middle East, Norway, Iran and Venezuela in response to the demand growth. Major oil company mergers followed the price decline which brought about high- grading of projects, significant decrease in capital expenditures and reduced the production growth. This in turn, prepared the ground for the price kickoff post 2002.
The 1986 – 2002 period was an extensive grind, since the determination of oil prices came from the long term minimal costs of gradational production and the sources were to meet the demand growth and serve as a replacement for the declining production from full- fledged oil fields.
Significant supply shortages were caused due to the strictly controlled well head natural gas prices during the 1970’s.
The year 1985 saw an introduction of order from FERC, Order No. 436. This resulted in a shift of regulation of interstate pipelines. A voluntary framework was instituted according to which interstate pipelines could serve wholly for the transportation of natural gas, as opposed to being the merchants.
The advent of Natural Gas Wellhead Decontrol Act in the year 1989, facilitated a complete deregulation of wellhead prices. The year 1992 saw a final conclusion towards a competitive market, when the pipeline unbundling was made necessary by the FERC Order No. 636.
The decontrolled market enabled alternate sources of supply, provisioned by new seismic technological advancements that helped extricate large reserves of Natural Gas in the Gulf of Mexico. Between 1989-19999 Gas prices were held below $3/MMbtu. Cogeneration plants, primarily independently owned, sold electricity to industrial establishments and the grid at the prices that curtailed the additional costs which would have been incurred by new utility projects. This gave way to a rapid growth in demand. The demand however deflated with the peak of gas extraction in the Gulf of Mexico, natural gas price increase and the construction of LNG import terminals.
Invention is the mother of necessity and thus did the higher prices compel innovation and George Mitchell discovered the process of extraction of natural gas from tight shale rock. Other gas projects and the oil shale projects too witnessed the deployment of the technologies.
Many historians will tell you that history at large, is built of patterns that are cyclical. This means that while history does not mandatorily have to repeat itself, it will certainly rhyme. Should history repeat itself, we should expect the oil prices to remain low for a long extensive grind similar to the 1986-2002 phase by tumbling further through the next 15 years. The gas prices should in this case be expected to strengthen in 2019.
OPEC's pledge to reduce the global inventories with Russia's support and share is being put in a tight spot with the US Shale surge. However, the indispensable want of cash to meet social obligations will most likely trigger a reduction in funding for capital expenditures of the national O&G companies. This will lead to lower production, even in the face of OPEC quotas. So we can easily expect the downturn to be shorter this time - much shorter than those 15 years in the past.
The role of politics this time around
In the month of March this year, the Trump administration rescinded an Obama-era policy that banned coal leasing on public lands across US. This has made it difficult for the natural gas to displace coal at the pace seen in recent years. In 2018, the U.S. is set to become a net gas exporter on an annual basis for the first time ever. Even with the coming U.S. LNG export surge, the resources available in the shale plays in 2017 is much larger than the Gulf of Mexico's resources that were available in 1989. Natural Gas inventories are expected to grow but the prices should stay capped by coal until the mid 2020's.