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Friday, May 20, 2016

Nigeria and Oil: Looking beyond price collapse towards post recovery savings (2)

I will attempt to share the justification for this projection from the insights expressed by experts at various fora, and my own informed postulations.

Depending on which expert you talk to, and the perceived direction of the Chinese economy, you get three different views; a school of thought holds that the price of oil may be far from the top but closer to the bottom, while others believe that oil price will bottom out at about $20 per barrel. Yet another group holds that Oil price has reached equilibrium and will oscillate between $40 and $45 per barrel. The optimists believe that oil price will recover to between $70 and $80 per barrel towards the end of the year, and remain within that band, as a sustainable balance between demand and supply is reached.

According to the 2015 OPEC annual statistics bulletin, world crude production in 2014 was 73.4 million barrels per day (mbpd) while demand was 91.3mbpd. With the significant scale back in shale production arising from the steep price drop from late 2014 to levels that make shale production unviable, it will be safe to assume that production has dropped considerably while demand has more or less remained steady. The major issue for me is the question of the so called glut. If there is indeed a glut, what is the accurate size of the glut and therefore, how long will it take for supply and demand to balance out.

I listened to an expert at a recent forum argue very eloquently against the widely touted 850 million barrel excess crude inventory. Based on the data he and his firm have meticulously collected, he believes that the excess supply cannot be more than a quarter of the touted figure. This means that the glut is overstated by 600 million barrels. Meanwhile, Iran’s return to the market has been less dramatic than the Iranians said it will be, adding only 220,000 barrels per day (bpd) in February 2016 according to the International Energy Agency (IEA); only a fifth of their forecast of 1mbpd. The IEA also believes that non-OPEC output will fall by 750,000 bpd in 2016, while US production alone will decline by 530,000 bpd this year.

The other possible disrupter to oil is the incentive to explore alternative forms of energy such as renewables, majorly solar and wind, in response to the impending carbon tax fuelled by fears of global warming and pollution. According to Amy Jaffe and Jeroen van der Veer, leading experts on global energy policy, factors such as technological advancements, the falling price of batteries that power electric vehicles, and a post-COP21 (UN Climate change conference in Paris in 2015) push for cleaner energy could drive oil use below 80 million barrels a day by 2040.

These threats to oil do not seem practical on a meaningful scale in the near to medium term. The example in Germany seems to buttress the fact that renewables may not make sense in Europe and other cold climes, and that they can only be achieved with very steep and unsustainable subsidies. It is reported that Germany, the poster boy for renewables has so far invested about $500b on wind and solar energy. And yet renewables account for only 3.5% of global energy use, while oil and gas accounts for as much as 60% (this excludes shale, peat and coal, which account for 10%). Electricity accounts for 18%, while biofuels and waste account for the balance 12%. In simple terms, the eight major oil companies, with a cumulative valuation of $1.4trillion generate as much as 20 million barrels per day versus the $2trillion invested so far to generate the equivalent of 7million barrels of oil per day in renewable energy. How sustainable is this huge subsidy?

For the switch to electric cars to happen, we would need to replace refineries producing petrol with power plants that will produce the additional electricity required to charge the electric cars. How quickly can this switch happen, even if it were practical?

My theory on the oil narrative is as follows: Saudi Arabia being the biggest reserve holder wanted to drive the shale producers, whom they saw as ‘squatters’ out of the market. They opened their taps to drive prices down, knowing that shale needed an oil price of above $40 to produce at break even. The high oil prices were driving cheap capital into shale and improving technology and yielding high returns and thus attracting more capital and repeating the cycle, thereby iteratively making shale a bigger threat. I believe that the Saudi plan was hijacked by the Oil traders, who thrive on price arbitrage fuelled by uncertainty. They rode on the back of increased Saudi production to shout 'oil glut'! 

They increased the FUD (fear, uncertainty and doubt) with news of huge inventories coming on stream following the lifting of sanctions against Iran, but the general view is that Iran's oil was already finding its way into the market through the back door, resulting in an insignificant net increase in supply. It then became a self-fulfilling prophesy which snowballed, with the producers pumping recklessly to maintain market share and preserve earnings, which drove prices further down, exacerbating a bad situation.

I believe that the oil traders and bankers are trying to make up for a lost bet on the back of overenthusiastic exposure to the oil market. This is captured by the screaming headline in the Financial Times of March 22, 2016 ‘$150b losses on energy company bonds spur default fears’. The article further states that the total debt among oil and gas companies including loans almost tripled from $1.1trillion in 2006 to $3 trillion in 2014 quoting the Bank for International Settlements. Twenty of Europe’s biggest banks have energy loans totalling $200b, enough to wipe out a quarter of their common equity, while twenty of the leading US banks have loans totalling $115b or 11% of their equity.

With the desperation arising from a risky bet gone awry, one does not need to dig too deep to glean a motivation to drive prices down, buy on the cheap and subsequently sell on the high to cover the huge debts.

I believe that in the end, the market will wave its magic wand, and supply and demand will correct themselves and reach equilibrium with price. You cannot hide a pregnancy for too long. It is not at all surprising that the heads of the world’s largest oil trading houses, six of which sell enough oil to meet almost a fifth of global demand were unanimous in calling for an end to the two year price slump at a Financial Times conference in Lausanne.

What should be more important to all of us, beyond these theories is whether Nigeria will finally learn from her past mistakes and institute a mechanism for saving when oil prices rebound, as I believe they eventually will. And what if the optimists are wrong, and prices do not rise. We would have lost nothing. We would have learnt to diversify away enough from oil to live comfortably within the current price. If on the other hand the optimists are right, then we will save the equivalent of $36.5b per year (i.e. 2.5mbpd X extra $40per barrel X 365 days). In any case we would have nothing to lose by preparing and having to wait a while longer than anticipated. Success only happens when opportunity meets preparation.

*Austin Okere is the Founder CWG Plc and Entrepreneur in Residence, Columbia Business School, New York. He also serves on the World Economic Forum Business Council on Innovation and Intrapreneurship.

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