Oil market attention has been on Saudi Arabia’s clear messaging to the market that it is prepared to make additional cuts to keep a stable market as this implies they are prepared to keep ceding market share to US shale. Al Falih said “We’re comfortable with where our production level is, we’re willing to go either way from where we are today to keep markets balanced”. But the more significant al Falih comment was “There will be a plateau for these unconventional resources in the US, the Permian being one of them. is it in a year, or two years or four years, I don’t know but certainly its not indefinitely.” No one is calling for Permian plateau (peak oil) in a year or two and not likely 4. Maybe people didn’t see these comments at 3:45am MT or maybe most assumed it was just musings from al Falih. But we think its more than musings because Saudi Arabia is taking a different tactic this time than their normal strategy to get market share – increase oil production, crash oil prices, ruin growth prospects for other oil basins. They want solid oil prices, an increasing oil market share, and strong oil outlook for the mid/long term valuation of Saudi Aramco massive oil reserves for the IPO. And this time, al Falih’s comments suggest they believe that, they can regain market share, by letting US shale play out. If Saudi Arabia is even directionally right in Permian reaching plateau (peak oil), it means that Permian and US oil is going to hit peak oil probably at least a few years earlier than expected. This will be very bullish to oil post 2020. Unfortunately, it will likely be impossible to determine if Saudi Arabia is directionally right in 2019 with the increased Permian takeaway in H2/19. But we expect to this call, or at least the confirming nor discounting views to this call, play out over the next 18 months. There is no certainty that Saudi Arabia will be right and it may just be an educated gamble, but it is something that should be at least considered as the thesis of an earlier than expected plateau in US oil seems to fit to the recent Exxon presentation that implies a ~7% decline rate in overall global oil supply. If these two views are right, it’s a big plus to post 2020 oil prices. Its not just oil prices, there are multiple implications to differentials, Gulf Coast takeaway, pipeline utilizations, Cdn light oil opportunities, etc. At a minimum, these view should at least give people a reason to at least consider the potential for better post 2020 oil prices.
If al Falih is even directionally right on his Permian call, it’s a big plus to post 2020 oil prices. We decide to write this blog because we didn’t see the markets focus on Saudi’s change in tactics to regain market share and what the implications are to post 2020o oil prices. Saudi Arabia may well be wrong on Permian reaching oil plateau (peak oil) sooner than everyone else expects, but its not musings, they are actually letting that call dictate a change in strategy to regain market share. And if Saudi Arabia is even directionally right, it means the Permian and US shale will be hitting plateau (peak oil) sooner than expected and this will have huge implications to post 2020 oil prices and a range of oil items ie. Gulf Coast infrastructure, Permian pipelines, differentials, etc.
Saudi Energy Minister Al Falih’s fulsome answer provides a clearer picture than a sound bite. The CNBC Worldwide Exchange interview with al Falih ran early this morning (345am MT). One of the reasons we like CNBC Worldwide Exchange or other overnight news is that they will play longer portions of interviews than the pre market opening shows that normally only provide shorter snippets. Of course, the exception being when they have an items like a exclusive Warren Buffet interview. For something reporting on the OPEC meetings, this won’t happen as all networks will be running sound bites from al Falih. Al Falih said some of these comments in sound bites yesterday post the OPEC+ extension. But as seen over and over, short sound bites do not do present the picture and this morning’s more fulsome coverage present the comments in a fuller picture. (i) Do not need to create a market share war and hammer prices to reach their objective. (ii) Prepared to wait out US shale. (ii) Every basin production ultimately peaks and then declines. (iii) Even under stable oil markets/prices, US peak oil plateau and Permian plateau (peak oil) in a year or 2 years or 4 years. (iv) Saudi Arabia will be there when that happens to regain market share. CNBC posted the video at [LINK]. Here is the SAF created transcript
Q: How fast do you see the Permian wells draining? Do you think we overestimate the longevity and the life of these wells in West Texas? Al Falih: “I think it’s not just in West Texas. All shale oil wells do decline rapidly, 70% of them, obviously in the US there is a fantastic service industry that keeps on drilling and fracking, completing the wells. So but its going to take a lot more money and resources to keep existing production base because of that decline, and any incremental production requires, of course, a lot more. We will need time to understand the geology and how much can we increase production. But in all cases, just like in any other basin, there will be a plateau. There will be a plateau for these unconventional resources in the US, the Permian being one of them. is it in a year, or two years or four years, I don’t know but certainly its not indefinitely. I think its really an oversimplification to assume that we can extrapolate a straight line forward and assume the same number of rigs that we have that production will continue to increase by a 1 million and a half or so a year. So I see production ultimately plateauing, is it in two or three years or four years, time will tell.”
Q: have US oil companies taken on too much debt? Al Falih “well definitely they have not been generating enough cash flow to their investors and I know that, in fact the appetite is for investors to continue putting money into unconventional resources. So the combination of infrastructure which has constrained, a combination of service industry constraints, financial constraints as well as the unknown constraints of geology will ultimately bring us back to reality that there has to be a plateau and ultimate decline. In all cases, we have the conventional resources ready to deploy and step in when its time. We’re comfortable with where our production level is, we’re willing to go either way from where we are today to keep markets balanced. We’re happy to have 23 other countries join us today, not only on the 9 month extension but on a permanent framework to continue to analyze and pre-emptively step in to prevent imbalances from taking place in the future”
Do not need to create a market share war today (crash oil prices) to support Saudi Aramco IPO valuation. Saudi Crown Prince MBS and al Falih have both recently stated the Saudi Aramco IPO is still expected in 2020. We believe that Saudi Arabia needs to have increasing oil market share, near term outlook for stronger stable oil prices to have a chance to support a big Saudi Aramco valuation. Al Falih’s new tactic is the biggest difference in their long term strategy. Going into the OPEC/non-OPEC meetings, one of the biggest risks to no OPEC+ extension was the stated Russia concerns about continuing the OPEC+ deal and ceding increasing market share to US shale. Many thought that Russia wouldn’t agree to a straight extension and would need some relaxation of their quota. Arguably, the Druzhba problems made it easier for them to agree to stay at reduced levels. However, Russia did come along. But looking at al Falih’s comments, its clear that they (rightly or wrongly) believe they can get to their goal without creating a market share war today (and crash prices) like they have done for the last 30 years. They don’t feel they have to increase oil production, get oil prices to drop, so that capex and production in the new growth basins loses its ability to attract capital and replace declines as their oil drilling only works at high oil prices. The ability to rein in new basin oil growth was dependent on having low oil prices. Whereas today, they don’t believe they need to crash oil prices to rein in new basin oil growth. Rather they are prepared to let US shale oil play out.
Their market share/price crash tactic worked in 2015/2016. This is the biggest difference in their tactics. It was only 4 years ago that oil prices were up $100, capital was pouring into the E&P sector, and there was growth around the world in high cost basins (ie. oil sands) and also the US shale. Saudi Arabia then went after a market share war that led to oil prices crashing to below US$30, and no surprise oil growth (apart from projects in execution) stopped. US oil production has just grown from ~5 mmb/d in Sept 2011 to 9.6 mmb/d in June 2015, but then declined by ~1.2 mmb/d in one year to 8.4 mmb/d in July 2016. Saudi’s oil market share tactic worked.
US Oil Production Vs WTI Price
But this time, Saudi Arabia is prepared to take the leadership role (ie. cut again) to keep a stable oil market even if they lose more market share. Saudi Arabia has seen the amazing success of US shale oil in the last three years with growth of ~3.8 mmb/d since July 2016. And al Falih acknowledges it will be giving up market share to the US over the near term. And yet they will still work to keep stable oil markets. This was the common takeaway from the al Falih soundbites yesterday as it should be because he seems pretty clear on this. Al Falih says “We’re comfortable with where our production level is, we’re willing to go either way from where we are today to keep markets balanced.” The general view (which we agree with) was that Saudi Arabia continues to stress the importance of stable markets, for both consumers and producers, it plans to keep production around current levels for H2/19 but, if needed to keep oil markets stable, is prepare to cut production further. The closing OPEC/non-OPEC statement [LINK] did not say anything about conformity to voluntary production levels, but one of the themes going into the meeting was that Saudi Arabia was expected other countries (read Nigeria and Iraq) to comply with their targets As much as al Falih was clear that Saudi Arabia was prepared to cut more to keep market stable, we believe there was also a Saudi reminder to the others that a first step is more countries complying to their targets.
Even under stable markets/prices, Saudi Arabia believe will reach peak oil supply and the Permian will reach plateau (peak oil) in “a year or 2 years or 4 years”. Its no secret that Saudi Arabia has been studying shale for the past several years in part due to developing their own unconventional gas resources. But, we believe the primary reason has been to understand the geology and competitive nature of US shale for the short, mid and long term. The interesting aspect of al Falih’s comments is that they don’t believe low oil prices are needed to stop US growth, rather under stable markets/prices, US shale is near reaching peaking oil supply and then will decline. Al Falih didn’t’ go into details on tier 1 vs tier 2 acreage rather clearly stated twice that US is going to reach plateau (peak oil) soon. Interestingly he chose to highlight the Permian reaching plateau soon. Al Falih said “There will be a plateau for these unconventional resources in the US, the Permian being one of them. is it in a year, or two years or four years, I don’t know but certainly its not indefinitely”. If markets start to see indications in 2020 that this could play out as Saudi Arabia suggests, it will be a huge positive to Saudi Aramco valuation.
Saudis US peak oil supply view also fits to the Exxon mid/long term view of global oil supply and demand. Perhaps the key reason why al Falih’s comments stood out for us was the recent Exxon sellside presentation that included their long term oil supply/demand views. We thought al Falih’s comments on an earlier than expected peak oil supply for the Permian (and the US) fits into the big picture challenge for oil supply in the Exxon outlook. Our June 20, 2019 blog “Exxon’s Math Calls For Overall Global Oil Decline Rate of ~7%, A Very Bullish Argument For Post 2020 Oil Prices” [LINK] said “We believe Exxon presented a very bullish argument for oil prices beyond 2020 and that it has been overlooked because most readers only flip thru a slide deck and don’t listen to or read transcripts of management’s spoken words. Exxon’s spoken words highlighted one of the forgotten (and perhaps most important) oil supply/demand concerns for post 2020 – the mid term challenge to replace increasing rate of overall global oil declines. And what is eye opening is Exxon’s estimated overall global oil decline rate, which is way higher than any we can ever remember seeing. Its impossible to tell from the small oil supply/demand graph in the slide deck, but Exxon’s spoken words says long term oil demand is 0.7% per year and then “When you factor in depletion rates, the need for new oil grows at close to 8% per year and new gas at close to 6% per year.” Exxon may not specifically say what the global decline rate is, but their math is that the world needs new oil supply to grow annually at close to 8% to meet the 0.7% annual increase in oil demand and offset declines ie. an overall global decline rate of approx. 7%. This is an overall global oil decline rate for OPEC and non-OPEC. This compares to BP’s estimate of overall global oil decline rate of 4.5% and we expect most are probably assuming something around 5%, certainly not above 6%. No one should be surprised by the increased decline rate given that high decline US shale and tight oil have increased by ~2.5 mmb/d in the last ~2 years. But an implied ~7% overall global oil decline rate is way higher than expectations. There is a big difference between needing to offset oil declines of ~7 mmb/d vs declines of ~4.5 mmb/d ie. an additional 2.5 mmb/d of new oil supply every year. Even if the implied difference was to 6%, it would still be an additional 1.5 mmb/d of new oil supply and that would also be very bullish for post 2020 oil. We recognize that the 2019/2020 oil supply demand story is the need for OPEC+ to keep cuts thru 2020, but Exxon’s math implying ~7% overall global oil decline rate sets up a very bullish view for oil post 2020. We believe the reality to replace oil declines post 2020 is overlooked.”.
Oil Supply/Demand (moebd)
Source: Exxon US Sellside Conference Presentation June 18, 2019