Guest blog by S. A. Shelley: A few years back, I wrote that at some point in the future (now-ish) oil produces may need to resort to providing incentives for ICE buyers, or undertake more extreme measures to ensure sufficient oil demand. Well, oil producers have not yet undertaken either of those steps and, as noted in a recent blog, we’ve now hit peak oil demand. So producers were resorting to the next best means of balancing the supply-demand equation by curtailing supply in order to support oil prices. At best this was a short term solution to a growing long term problem. Now with the beginning of the oil supply war, we see that curtailing supply has failed completely, and, as predicted in my February 2, 2019 blog, somebody has decided to produce the hell out of its reserves while there still is a market for oil. This will not be a short war; it will be long and drawn out, and the eventual winners will not be who everyone now thinks they will be. In Part 1 of my blog on this topic, I’ll examine the supply-demand history of oil over the past decade, which has set the stage for the dramatic changes in the industry that are just beginning. In the upcoming Part 2 I’ll explore the likely consequences.

Supply is Growing Faster than Demand and Losses

Examining global supply and demand data (see IEA, OPEC, BP, etc.) from the end of 2015 to the end of 2019 reveals that global oil supply was growing at a faster rate (approx 2% per annum) than global oil demand (approx 1.5 % per annum). I’ve selected a subset of oil production data corresponding to a group of 14 nations that in 2015 supplied over half of the world’s oil and that at the end of 2019 were still supplying over half of the world’s oil (Fig. 1).

A few things are surprising:

• In spite of deliberate political hostility towards oil and interference against oil in Canada, Canada managed to increase oil production (this will not make the neo-communists in Ottawa happy)
• Iraq is now out-producing Iran by a significant amount
• Russia increased production by about the same amount as Saudi Arabia cut production
• The U.S. shale effect is definitely noticeable

“The US is expected to remain the main growth driver in 2020, along with Norway, Brazil, Canada, Guyana and Australia.“ This sentence from OPEC’s February Monthly Oil Market Report reveals that Guyana, not included in Fig.1, is quickly become a significant supplier of oil to world markets with production forecasts of 1,000,000 bbls / day bantered about in Houston.

A few things are not surprising in Fig.1, namely that Angola, Mexico and Venezuela production has declined. The cumulative supply decline in these nations amounts to 3,000,000 bbls/ day resulting from political breakdown or graft and corruption sucking their industries dry. Recent news suggests that production in Libya has collapsed to just 72,000 bbls / day. That’s another 1,000,000 bbls / day of oil taken from the market supply.

Think about this: Over the last 4 years, the world has seen steady oil production growth that exceeded demand growth and even managed to offset 3,000,000 bbls / day of existing supply loss.  To every oil executive or investor, think about this in particular: If the next project is to bring 100,000 or 200,000 bbls / day of supply on stream in 5 years, will that supply add to the supply glut or is it meant to replace some diminishing production elsewhere?

Economics 101 Refresher

#1. Small shifts in price cause movements along the supply or demand curves.

#2. Externalities including demand shocks or changes in technology cause movements of the supply or demand curves.

#3. In the long run, we are all dead.

If the world is flush with oil supply, which then drives down prices, then there should be rebalancing of the supply-demand market. But this is not what’s happening. Until this supply war broke out, crude oil supplies, especially in the OECD countries have been very steady for some time (Fig. 2) despite low prices which should otherwise reduce inventories by stimulating demand and consumption of that oil.

For the most part, the oil supply and demand curves have been closely correlated (Fig. 3).

However, under closer examination of Fig. 3, apart from 2008 to 2009, it becomes evident that oil supply has consistently exceeded demand, and this has resulted in the steady build and maintenance of oil inventories in the last decade. In the U.S. we’ve started to see more frequent and unexpected inventory builds than drawdowns. Furthermore, who knows how much oil inventory is hidden in China or other less transparent countries? 

With a world already awash in oil and demand leveling (and likely decreasing even more once the full toll from the coronavirus outbreak is understood), the Saudis and Russians decided to start a supply war. Stay tuned for Part 2 to help understand the dramatic and likely irreversible impacts on the world oil industry.

Vive l’Alberta Libre!