Trend: Demand for oil continues to grow, while supplies continue to dwindle.
Marin Katusa at Safehaven.com describes why oil prices won't go much lower.
Reason 1: "The Big Pinch"
Oil production levels, as well as exports, have been falling in most of the world's top ten supplier nations:
The "Seven Sisters of Declining Exports" – Saudi Arabia, Iran, Nigeria, the UAE, Norway, Venezuela, and Kuwait – share one common characteristic: their oil fields are old. Oil fields don't produce the same amount year after year. They decline significantly from one year to the next because each barrel of oil taken from a reservoir reduces the pressure within the field, leaving less force available to push the next barrel of oil up the well. But don't take our word for it. The following chart shows production from Alaska's North Slope oil field in the past 30 years:
Another example? The Cantarell field in Mexico, which produced 2.1 million barrels per day in 2003, produced just 400,000 barrels last month, a staggering decline of more than 80% in just nine years.
To maintain output levels, producers need to consistently invest huge amounts of money and time in exploration, development of new areas, and engineering and utilizing new technologies to extend oil field lifespans. All of this costs money, and lots of it. Of the Seven Sisters of Declining Exports, six are countries where the oil machine is run by a national oil firm. That means that revenues from oil exports belong to the government… and those governments are stuck between a rock and a hard place.
They know they need to direct the oil revenues back into their fields very soon, before they decline beyond the point of repair. In the meantime, production levels continue to fall. Compounding the problem of declining production is the fact that most of these countries have long relied on cheap domestic fuel prices to keep their citizens happy. This has spurred rising consumption in many oil-producing countries, including Saudi Arabia, Iran, Nigeria, United Arab Emirates, Venezuela, and Kuwait.
With domestic consumption climbing and production falling, these countries have less oil available for export every year. But here's the hard place: oil export monies make up the vast majority of each government's revenue. They need to sell oil on the international market in order to fund their day-to-day operating expenses. And their operating expenses are sky high: these governments constantly make new social-spending promises to appease their masses; and since their populations continue to grow, these commitments grow larger with each passing day.
Venezuela is a prime example. Hugo Chávez owes a big chunk of his popularity to the domestic fuel subsidies that render fuel prices in Venezuela among the lowest in the world – it costs just US$0.18 per gallon to fill up in Venezuela, and that's ridiculously expensive compared to the US$0.05 per gallon it cost a year ago. Yes, that means you could have filled your car for $1 in Caracas.
Getting rid of these fuel subsidies would solve part of the problem, but it is simply not doable – it is not just political suicide, but a sure-fire way to incite riots and social unrest. Just a few months ago Nigeria's government tried increasing domestic gas prices; the country rapidly descended into violence as protestors demanded a return to subsidized fuel. The government relented within days.
Fuel subsidies are not the only expensive item on many a government's social-spending list. Housing, food, health care, education – these are all burdens that socialist-tending governments take on to cement support. Social spending is a great way to make yourself popular with your citizens, but it is also a great way to bankrupt your country… unless, of course, you can sell oil at high prices to other countries. According to our analysis, OPEC nations need the price of oil to stay above $60 per barrel to pay for all their social programs. In other words, they need $60+ oil to stay in power – and you can be certain they will do everything necessary to make sure this happens.
To sum it up: Governments in most of the world's key oil export nations need more money from fewer barrels of oil, and it is a lot easier to hose your international customers than your own citizens. This results in "The Big Pinch."
What is "The Big Pinch?" In simple terms:
Declining production + increased domestic demand = Less oil available for export
Revenues from oil exports must at least remain stable, if not increase, to meet domestic budget needs
Oil export prices must increase.
Reason 2: Natural Gas and Oil – Different Markets, Different Outlooks
Natural gas and oil are both hydrocarbons, and analysts frequently discuss the two as if they are one and the same, but they are very different commodities with completely separate market mechanics. To summarize: oil is a global commodity while natural gas is a regional commodity.
Reason 3: Natural Gas is Not Oil
There is no way natural gas will replace even a fragment of oil demand during the time frame in question, which is the next 12 months. Oil is entrenched as the world's mainstay fuel; gas has always been second or third on the list of energy-resource importance. Changing the ordering on that list will take decades, if not generations. How many natural gas fueling stations do you drive past on your way to work? Not many, I'd bet, especially compared to the number of gas stations in your neighborhood. Do you see that ratio changing much in just 12 months?
Reason 4: My Country, My Oil
I believe we are in the early stages of the "Decade of Resource Nationalization." As supplies tighten, natural resources of all kinds will become more and more valuable. Whether to control additional revenues or to secure domestic supplies, governments will nationalize natural resources with gusto.
The latest example of this is Argentina. A beautiful country with incredible geological potential, Argentina's resources are wasted on a government that is simply unable to incentivize private investment in the country. Now the government is going to try to develop its technologically challenging oil fields alone, and mark my words it will fail.
Reason 5: "Shale Revolution" – A Purely North-American Phenomenon
It is not easy to drill an economic shale well, whether for oil or gas. To get the most out of a shale formation, an operator often needs to use a high-power – over 25,000 horsepower – frac drill set. He has to drill horizontally, which is far more technical and challenging than drilling vertically, and then has to complete multiple fracs to get the well flowing.
North America has more energy infrastructure than anywhere else in the world, resulting from years of conventional oil and gas development and production. In North America it is relatively easy to find drilling companies armed with these high-power frac sets, but such is definitely not the case in most other parts of the world. Europe, for example, is home to fewer than one-tenth the number of drilling and fracking sets as there are in North America. That means any shale revolution in Europe would take a very long time to develop –the equipment and expertise just aren't there.
Reason 6: The Easy Oil Is Gone and Shale Oil Wells Decline in a Big Way
The IEA estimates it costs between $4 and $6 to produce each barrel of oil from the conventional fields in Saudi Arabia and Iraq, including capital expenditures. Algerian, Iranian, Libyan, and Qatari fields cost slightly more, at about $10 to $15 per barrel. These countries produce most of their oil from relatively easy, straightforward, conventional deposits.
My perspective on energy resources revolves around the fact that there are no more of these big, easy deposits to be found. The deposits of tomorrow are harder to find and more complicated, expensive, and risky to develop. Companies now have to manage the litany of challenges inherent in getting oil out of places like the oil sands, sub-salt deposits, and ultra-deep offshore reservoirs.
Reason 7: The World Is Always Hungry for Oil – and Oil Deposits
The world is not awash in oil. On the contrary – we produce only just enough oil to meet global demand. With the world's population growing every day demand continues to rise, making the balance ever tighter. Even the threat of major production cuts of the sort we just discussed – which would surface the moment the oil price fell to $85 per barrel – would be enough to send tremors through the global oil machine and push the price of oil back up.
Reason 8: A Falling Oil Price Means Big Chunks of Global Reserves Uneconomic
If exploration drills find an oil deposit, data from those drills are used to calculate a "resource estimate," which is a geologic best-guess of how much oil the formation holds. However, oil in the ground is not necessarily oil that will ever see the light of day. That's where the "reserve estimate" comes in. Reserves are an estimate of the amount of oil within a deposit that can be extracted economically.
Reason 9: Between the Lines – By-products
One reason that North-American gas producers continue to drill select wells is because certain shale reservoirs contain lots of Natural Gas Liquids (NGLs). These liquids, comprised of bigger carbon molecules than the methane that is natural gas, trade at a significant premium to natural gas. Furthermore, these NGL-rich natural gas wells often also produce some oil.
Reason 10: Black-Swan Events – The Fragile Supply-Demand Balance
A "black-swan" event is a rare but highly significant event with dramatic impact. The collapse of Lehman Brothers, the Arab Spring, and the Fukushima nuclear disaster are all examples of black-swan events.
These events tend to tilt more in favor of a rising oil price. Consider this: the loss of oil production from Libya – which represented just a small fraction of the world's production – caused the price of oil to move 25% in just two months.