Next to Arabian royalty, business journalist John Defterios of CNN is the closest you’ll get to an oil insider. Based in Abu Dhabi and with a contact base built over decades at the top of his profession, he has been accurately calling the crude price of oil for some years. In this fascinating discussion around regional geo-politics and the oil sector’s demand and supply challenges, Defterios explains why he has joined those tipping crude will get back above $50 a barrel in 2016. – Alec Hogg
Alec Hogg is with John Defterios, a very famous broadcast journalist from CNN who’s based in Abu Dhabi.
This is my fifth year in Abu Dhabi, having covered the Middle East off and on for 20 years.
How many times have you been here in Davos?
This is year 25 in Davos. My first was in 1990. I missed one year, so it’s 26 years but actually attending 25. My first meeting was probably the most interesting because it was a month-and-a-half after the fall of the Berlin Wall, so we had Gorbachev, Yeltsin, Cole, Modrow of East Germany, Thatcher, Miterand, and the U.S. administration guys trying to build Humpty Dumpty back together again after the Fall of Europe. It was an unbelievable meeting of historical proportions – only about 400 people instead of 2000 people.
They haven’t given you a gold badge or something special to celebrate that 25th anniversary.
It’s funny that you say that. There’s a pen they give you after you attend ten. It doesn’t get bigger although I think after you spend 30 years here… On the 25th anniversary they just said it was really great. They have a Golden Circle reception for people who have attended for that many years. There’s only one other journalist in that crowd, so they usually don’t invite journalists to attend. It’s good. I think about 70 percent of my rolodex is linked to my attendance at Davos as an incredible networking event despite the criticism that it’s become too big or too commercial. It’s phenomenal for the relationships you can build here – even the one where we’ve been in the same hotel, right?
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Expanding your knowledge base as well, although you share a lot of knowledge too being based in Abu Dhabi, following the oil story and every time we talk about it you’re on the money. We’ve see the oil price now, hit surely close to bottom levels. What’s your reading?
We tested 26 during the week of Davos and we may have found the bottom during Davos. I did a panel called the New Energy Equation and we had the Chairman of Saudi Aramco, the Minister of Energy from Nigeria, the President of Azerbaijan, Daniel Yergin who’s writtenone of the most seminal books on energy called “The Prize”. He has two main books, The Prize and The Quest FYI. They all agreed that this was an oversell; that the marginal price of oil has to be above $30.00 per barrel but we have a supply and demand problem and we have geopolitical problems. The supply and demand problem is that they’re producing about 1.5 million barrels per day too much and there’s excess supply coming forward with Iran coming back to the market. The geopolitical problem is that Iran and Saudi Arabia are rivals.
Saudi Arabia took Iran’s market share under sanctions, which was about 1.5 million barrels per day and they won’t give it up. That was confirmed during our panel. Iran’s going to come back to the market. The market underestimates Iran’s capabilities because they were in Iran four months ago and they guaranteed and said to me (on the record) they could add another million barrels per day by the end of the year so that overproduction could be two to two-and-a-half. It means the oversupply is going to be heavy. The big equation we need to look at is whether the shale production and the deep water expensive production comes off just as fast as Iran is coming on and that you’ll have an equilibrium. Right before Davos there was an interesting Wood-Mackenzie report that’s worth looking at, suggesting that nearly $400bn of deep water projects and some OPEC members and non-OPEC members (Kazakhstan, Nigeria, and Angola) – big, major projects were cancelled because of the low oil price.
The bottom line story is the Saudi Arabian strategy to fight for market share and not put up the prices. It’s very painful for all these countries but it will work. It will just take a year longer than they expected so a very painful 2016 in terms of prices. The extras I’ve spoken to (and there’s quite a few on that panel alone) and even after discussions in Abu Dhabi, we’re suggesting that we could get to 50 by the end of the year – in the range of 60-70 by 2017/2018 and that’s a liveable Goldilocks price, Alec. We talk about ‘not too hot’ and ‘not too cold’. It used to be $100.00/barrel but in that range of 60/70 everybody can make money. The world has oil. It’s not oversupplied. They’re not laying off people in the oilfields. The only challenge is that at $60.00, shale production is really productive and it can come back rather quickly because they’re very flexible and dynamic.
They can shut a well down now and be very efficient, and come back on when the price is right so it’s going to be challenging for the next three to four years, as a result.
How big (at $30.00/barrel) is the shale output? Are some of them continuing just to stay in business or are they pretty much gone?
It’s very interesting that you say that because not only shale producers are alike. This has been the grand shake-out. A lot of wells have come off. They were profitable at $60.00//barrel 18 months ago and the strategists that I’ve spoken to about this have suggested that many can be productive at 30-35 and still make money (or break even) at 30. This is the flushing out period because we’re at 30. There’s a lot of debt in the shale business and that’s going to be the next trough down. I think there’s about $200bn of debt in the U.S. shale market already and a lot of the companies carrying the debt can’t service the debt at 30, and so it’s washing out the marginal high debt players in this process. Watch it carefully because you’ll see more bankruptcies and that production will come down. There are 5000 wells drilled and 1500 active, and when the price comes back up again you’ll have 3500 wells that can return if the price is right. They’re very flexible. Deep water’s not flexible. It takes many years to develop it. It’s very expensive. It’s going to go away.
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So the big story for the Saudi’s is that they’ll carry on pumping, put the deep water out of business knowing that the shale come back on stream between 30 and 35 because it’s been billed as a war between OPEC and the shale producers whereas the way you’ve explained it, it’s not quite so.
Yes. It’s partially that because they know that not all shale can be profitable at 35. A good, efficient shale producer will survive. Half of them won’t survive because it’s $50/$60 and above. Deep water: major investments that take years and billions of Dollars to develop are going to go away for a while. A really interesting angle that your listeners should focus in on is that it’s going to boomerang. They’ve already cancelled $400bn in contracts for the next five years. It will probably be double that in the next five years after that. You’re going to have a shortage of new capacity coming online because demand is rising. You could have an instance where the Middle East doesn’t have 35 percent of the global market share but up to 50 percent of the global market share by 2030 because they produce between $2.00 and $10.00/barrel. Saudi Arabia produces at $2.00 to $4.00.barrel on shore.
The same thing with Abu Dhabi. Their budgets are expensive and they’ve brought down their budgets now (their national budgets) but their production costs are the lowest in the world. It’s like sticking a straw in the desert and $2.00 to $4.00/barrel is extraordinary. It’s a similar case to the UAE.
John, you mentioned that the budgets have been cut in the UAE. By how much? How aggressive have they been in pulling back their expenditure?
What I find intriguing about the UAE (having lived there) is that they have about $1trn of sovereign wealth in Abu Dhabi in particular, because that’s where 95 percent of the oil revenues are and as soon as the oil prices started to go down, they cut their budgets [I understand] by 30 percent. Some people suggest more but I don’t know that for a fact. They have nine million people in the country – 1.5 million in Emirates, more than $1trn of sovereign wealth and they still have budget discipline to suggest ‘we’re not digging into our savings because we should be able to live off of our production of nearly three million barrels per day’. Saudi Arabia just went through the exercise and raised gas prices by 50 percent. They’re cutting power subsidies and food subsidies so it’s a painful transition. Bahrain has done the same.
I think the story of 2016 is the emerging market commodity-dependent countries. In Russia, the Rouble is down by about 80 percent. Azerbaijan’s currency is down by 70 percent. The Kazakhstani Tenge is down dramatically. Nigeria’s is under pressure. Algeria… Anybody linked to oil or metal commodities have seen that big boom collapse in commodities – even South Africa. The currencies are under pressure and I think it’s an underreported story of 2016 that the emerging markets that will go through incredible dislocation (and I put Russia at the top of the list because they have not diversified enough).
Read also: US Frackers struggle to survive at $35; for SA, shale gale opportunity gone
Just to close off with, if you were to summarise the oil picture the way you put it – maybe getting to $50.00/barrel later this year… Goldilocks scenario taking it even higher than that?
Yes. I think we have to watch the politics within OPEC itself. There are 13 members. Nine want to do something because they’re suffering so badly on the revenues. Four major players led by Saudi Arabia, UAE, Kuwait, and Qatar want to leave things the way they are because they want to smoke out the high cost producers. There are internal tensions, which I know about and I don’t know how you settle that. Either make OPEC irrelevant in the future because they can’t get along or they find an agreement to when this is going to pay off for even the higher cost producers. That’s the geopolitics of it. Will Russia finally crack, come to OPEC, and say ‘we’ll cut production’? Russia’s at the highest level ever – nearly 11 million barrels per day so it’s OPEC/non-OPEC. Who blinks first in 2016? If nobody blinks, high cost projects go by the wayside and it’s going to be a longer correction because everybody’s pumping so much crude onto the market today.
To simplify that: Russia – nearly 11 million barrels per day. Saudi at nearly 10.5 million barrels. U.S. production is at 9.6 barrels down to about nine right now – probably going down because of the shale reduction to 8.5. The dynamics between those three players is about making sure that the tensions between Saudi Arabia and Iran don’t go up to the next level and then ‘how fast does Iran come into the market’. Those are the dynamics you should watch for the year. If we stay at the status quo and nobody cuts production with that additional money that’s not getting invested in the market, I think you could see $50.00 by the end of the year.
John Defterios is the CNN correspondent in Abu Dhabi and an oil expert, and he’s been guiding me very well over the years on crude. I think you should listen to him.
