Crude: Big is never big enough!

Daily Energy Market Analysis

The biggest, best, massive tax cut plan in all human history was not enough to shake the petroleum sector out of its bearish slumber. The petroleum sector has been dripping down slowly like a good old fashion water torture as the market is fixated on short-term supplies and not our future. While the market continues to believe that shale oil is going to plug the gap in the global oil market, it will at some point find out that shale oil is a band-aid on what is becoming a gaping wound.

Just yesterday the International Energy Agency (IEA) reported that global crude oil discoveries fell to a record low in 2016 as companies continued to cut spending. The IEA said that sanctioned conventional oil projects are at the lowest level in more than 70 years and warned that both trends could continue this year. "Every new piece of evidence points to a two-speed oil market, with new activity at a historic low on the conventional side contrasted by remarkable growth in U.S. shale production," said Dr. Fatih Birol, the IEA's executive director. "The key question for the future of the oil market is for how long can a surge in U.S. shale supplies make up for the slow pace of growth elsewhere in the oil sector.”

That is the question that I pose. I fear that an overreliance on shale oil for future demand growth is putting the global economy at risk. The short lifetime of a shale well and the fact that big oil companies are going to shale not because they necessarily believe that is the answer to meet demand growth, but where these companies with mounting losses can make a quick buck to offset major losses over the past oil projects. But if you look at the math, the lack of investment in conventional oil projects is adding up to the loss of billons of barrels.

According to IEA data, oil discoveries declined to 2.4 billion barrels in 2016, compared with an average of 9 billion barrels per year during the past 15 years. That is a loss of potential future supply of about 6.6 billion barrels. How long will it take shale producers to increase footer output to replace 6.6 billion barrels of oil?

Just the volume of conventional resources sanctioned for development last year fell to 4.7 billion barrels, 30% lower than the previous year, as the number of projects that received a final investment decision dropped to the lowest level since the 1940s according to IEA data. The IEA says that the sharp slowdown in activity in the conventional oil sector was the result of reduced investment spending driven by low oil prices. It brings an additional cause for concern for the global energy security at a time of heightened geo-political risks in some major producer countries such as Venezuela. 

The slump in the conventional oil sector contrasts with the resilience of the U.S. shale industry. There the investment rebounded sharply and output rose on the back of production costs being reduced by 50% since 2014. This growth in U.S. shale production has become a fundamental factor in balancing low activity in the conventional oil industry. The loss of conventional oil supply is a growing problem. The IEA says that conventional oil production of 69 mb/d represents by far the largest share of global oil output of 85 mb/d. With global demand expected to grow by 1.2 mb/d a year in the next five years, the IEA has repeatedly warned that an extended period of sharply lower oil investment could lead to a tightening in supplies.

That is out of sight out of mind as we are being blinded by the flash in shale oil production. It is not that I am saying that shale oil production is insignificant because I am not. I am talking about the potential for shale to change the global energy space before most people even knew what I was talking about. Yet, my concern is that an overreliance on shale oil is going to lead us to a short oil market in the future and that may develop faster than we think. That is a growing risk to the economy as the market seems immune to the growing upside risks. Remember, it is not high oil prices that hurt an economy, it is spiking energy prices that hit us out of the blue that causes price shock even if we should have seen it coming.

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About the Author

Senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor.