Lauerman: Another Oil Price Boom On The Horizon?

The Daily Oil Bulletin published several articles about the International Energy Agency’s World Energy Outlook 2020, its latest long-term scenarios, when released on Oct. 13. And by simply glancing at their titles I knew which one of them would be the most read — IEA Warns That Ample Global Crude Supply ‘Should Not Be Taken For Granted’ — although I must admit to being surprised it only came in second place among all the articles published in DOB that day.

How did I know it would be the most read of the IEA-related articles? Am I a clairvoyant? Do I own a well-functioning crystal ball? No, I simply learned of an extremely important concept in a cognitive psychology class during my first round of university in the first half of the 1980s — when I got my master’s in economics — known as confirmation bias. To quote Wikipedia:

“Confirmation bias is the tendency to search for, interpret, favor, and recall information in a way that confirms or supports one's prior belief or values … The effect is strongest for desired outcomes, for emotionally charged issues, and for deeply entrenched beliefs … Confirmation bias is a result of automatic, unintentional strategies rather than deliberate deception … [It] cannot be avoided or eliminated entirely, but only managed.”

I’ve fought hard my entire four-decade career as an analyst to counter confirmation bias, and I know firsthand it can be no more than managed. For example, early in my career, I worked full-time as a macro-speculator — playing the futures markets on everything from gold, copper and oil to currencies and stock indices — after making a tidy sum on Black Monday, the October 1987 global stock market crash. Despite forcing myself to read articles and research contrary to my views in an attempt to cut my losses short, I still at times suffered confirmation bias, as it’s even harder to overcome when you have serious skin in the game. This ultimately contributed to the end of my speculator career after about four years.

Alberta bias

And what do we Albertans all desire? Well, another oil price boom, of course. Frankly, I’m shocked we haven’t seen a revival of the old 1980s bumper sticker — “Please God, give us another oil boom, we promise not to piss it away this time.”

A prime example of us Albertans desiring substantially higher oil prices, but our view of the world possibly being impacted by confirmation bias can be found in the Kenney government document Alberta’s Recovery Plan, released in late June. The report stated:

“Every credible forecast of future world energy consumption sees oil and gas continuing to dominate the supply mix for the next several decades. Average private sector forecasts estimate that global oil and gas [sic] prices will recover to a West Texas Intermediate Benchmark of at least $60 a barrel within 12 to 18 months following the return to global demand post-COVID. Many projections foresee significantly higher prices [by] 2023 because of a possible supply shortage due to a reduction in spending on exploration and production. In that environment, Alberta’s capital-efficient oil and gas sector is set to thrive …”

The IEA did warn that ample global oil supply shouldn’t be taken for granted! But, unfortunately, the agency has its own sorts of biases (to be discussed below). At the same time, even in its ‘good’ scenario, the Stated Policies Scenario (STEPS), Canadian oil production remains flat between 2019 and 2040 at around 5.5 million bbls/d, with a small increase in bitumen output from the oilsands making up for a small decline in conventional oil production.

IEA bias

The IEA suffers from institutional bias, as well as confirmation bias, like the rest of us. The agency was founded in 1974 following the First Oil Price Shock in 1973-74. A free-for-all broke out among many major oil importing countries in the OECD in the wake of the Arab Oil Embargo as they desperately searched for oil to supply their developed economies. This caused a more than fourfold increase in crude oil prices and hard feelings among otherwise close Western allies during the Cold War.

The IEA was established to help those countries respond to future oil supply disruptions in a co-ordinated manner, serve as an information source about the international oil — and other energy — market, and hopefully foresee future shortages of supply. As a result, the agency comes by its institutional bias of seeing a potential oil supply shortage under every bed honestly, since oil security was its original raison d'être.

The most recent example of the IEA ‘crying wolf’ can be found in the foreword to the 2017 edition of its medium-term oil outlook. The agency’s executive director, Fatih Birol, warned of a possible oil price spike by 2020 despite the rapid rise of U.S. light-tight oil (LTO) production earlier in the decade. He wrote:

“While the U.S. oil industry is seeing a revival, the dramatic declines in global oil industry investment over the last two years, and only modest signs of recovery in 2017, mean that it is far from clear that enough projects will enter the pipeline in the next few years to avoid a potentially tight market by 2020 and with it, the possibility of a price spike.”

Instead, in 2020 we got another oil price war in an attempt to derail rapid growth in U.S. LTO production, led by the Russians this time rather than the Saudis, massive oil demand destruction caused by the global COVID-19 pandemic, and an oil price crash of historic proportions.

WEO 2020

And despite this, the IEA is back to its old tricks in the latest edition of WEO, warning low oil prices could contribute to a lack of upstream investment as global oil demand rebounds and rises over the next decade under STEPS, possibly causing another supply crunch somewhere along the way.

“The U.S. tight oil sector has been the main engine of supply growth in recent years, but it was fuelled by easy credit that has now dried up. Meanwhile conventional producers are also feeling huge strains from the collapse in prices and revenues,” the IEA wrote.

In particular, the agency cited producers such as Iraq, Angola and Nigeria as facing ‘acute fiscal difficulties’ that will negatively impact their ability to mobilize needed upstream investment.

But this seems a stretch for both U.S. LTO and hard hit oil exporting countries. Iraq, Angola and Nigeria all have relatively low-cost reserves to develop, and if their state-owned oil companies don’t have the needed cash they can always sweeten contract terms to entice foreign oil companies to step in and invest.

In regards to U.S. LTO, the IEA at least had the decency to project output to rebound to 2019 levels by 2022 under STEPS, and remain only slightly below levels projected in WEO 2019 through to 2040. The agency severely underestimated growth in U.S. LTO production most of the past decade, with forecasting errors when comparing final year forecasts to actuals for their medium-term outlooks — five years out — averaging well over three million bbls/d.

It is true capital and credit is drying up for smaller producers, but the U.S. LTO patch is becoming dominated by larger, more technologically-adept and deep-pocketed companies such as ExxonMobil, Chevron and ConocoPhilips, which could ultimately be a net-positive for the industry.

Anyways, projected annual growth in global oil consumption is not expected to be overly robust in the next decade, even under STEPS (see Figure 1). The IEA is projecting oil demand to rebound to 2019 levels by 2023, and then grow around 750,000 bbls/d per year through to 2030 under STEPS, for average annual growth of 480,000 bbls/d over the 2019-30 period. In contrast, global oil consumption grew an average of 1.17 million bbls/d per year between 2010 and 2019.

Sources: IEA World Energy Outlook 2020; Geopolitics Central

At the same time, STEPS is a relatively optimistic scenario for oil —and other fossil fuel — consumption compared to the IEA’s other main scenario, the Sustainable Development Scenario (SDS). STEPS incorporates an agency assessment “of all the policy ambitions and targets that have been legislated for or announced by governments around the world,” whereas SDS assumes net-zero greenhouse gas (GHG) emissions in 2070 and works backwards.

Global oil consumption is not plausible under either IEA scenario, despite the totalitarian Chinese government recently committing to net-zero emissions by 2060 and Joe Biden, the likely winner of the upcoming U.S. presidential election, promising his administration will adopt a target of net-zero by 2050. As a result, Geopolitics Central created a Hybrid Scenario by taking a simple average of changes in global oil consumption under STEPS and SDS. An average annual decline of 280,000 bbls/d over the next decade suggests the likelihood of an oil supply crunch due to a lack of upstream investment is next to nil.

To conclude, I’d love another oil price boom as much as the next Albertan. But for one to happen we would likely need a major geopolitical event in the Persian Gulf region to cause a large and prolonged disruption to oil supplies — unlike the cruise missile and drone attack on Saudi Arabia’s massive Abqaiq oil processing plant in September 2019, which only caused a large and short disruption. As a result, we all should play it safe and plan and budget as if high oil prices are a thing of the past, rather than betting the farm on a long shot.