Leader of Sub-Saharan Oil & Gas M&A Advisory at Deloitte, Claude Illy joined Alec Hogg in the CNBC studios to discuss the potential mining style ‘boom and busts’ that the global oil sector may be facing.Â
When someone in the industry says that the oil price will stay around $45.00 to $50.00/barrel, you must know that’s their most optimistic assessment. Presumably, that means it could go further down.
It could go further down. As Bob mentioned, there’s still a large oversupply in the market, more than 1m barrels per day of supply, which is higher than demand so that’s going into storage right now. The supply matches demand plus all the inventories taken away from the market. We don’t expect a recovery in oil prices.
With the potential additional supply from Libya, as well as new potential suppliers Iran and Iraq, it doesn’t look good for oil bills, does it?
Indeed. Even in the U.S., they’re still forecasting increased production in 2015 versus 2014 in spite of the drop in recounts. As Bob Dudley mentioned, the number of drilling rigs operating in the U.S. is dropping. There is a time lag effect, and we still expect all production in the U.S. grow this year.
What about Africa? Before we go onto the big picture of the oil price into the future, there was so much excitement about African discoveries coming on stream. Are they now at risk?
Yes. A few marginal discoveries are at risk in various countries, such as Angola, which is quite expensive. Potentially, Nigeria, because of the high cost of operating there so all the exploration and production companies, including all the majors are reconsidering their capital budgets for 2015 and focusing on ‘what’s the quickest buck for the money’. ‘What do I invest in’, which is low-risk or low-risk development, but the marginal fields will be pushed back.
Do you anticipate something similar to the recent cutting of higher cost producers occurring in the mining sector in the oil market?
I think it’s going to be the same. It’s about market share, squeezing out the smaller players or the marginal players, and automatically, the ones who have high cost operations in order to match supply and demand in the long term.
Of the current supply into the market, how much of it is operating at a good margin? In other words, coming to market at below $20.00 or $30.00/barrel.
In terms of cost of production: excluding the foreign investment that you have to recover, the whole Middle East produces at a cheap cost. On shore, it’s Africa as well, so most of the on-shore production is usually at a cheaper cost. Some of the North American production is profitable as well, at $30.00 or $40.00/barrel. If you start factoring in the development costs then obviously, there’s a different scenario.
So the decisions into the future are going to have to be weighed up more carefully. Your research suggests that the oil price itself could become more cyclical in future?
Yes. As with everything, your price is fundamentally driven by supply and demand. We’ve seen the rally up to 2008, which was driven by high demand from China and supply, which was not keeping up. Then we obviously had the global financial crisis where demand dropped, and the oil price dropped materially. What helped prices to recover, was the OPEC cutting production in 2009, so that was then a supply-driven recovery. Now, we have supply exceeding demand and because of this, we’re going to have a flat oil price. In possibly five, six, seven years’ time, we will see a spike in oil price again, if there is underinvestment in exploration now, which is what is happening.
Five, six, or seven years. That’s a long time.
There will be a gradual recovery, but it could be a material spike, much later in the future, because the projects that were supposed to be explored and pre-developed in this period have been shelved. When the demand picks up again and the supply doesn’t match, there will be an issue.
What would you say to someone asking what you think about the Sasol share price?
I would say that this is not the time to sell. The oil price can drop further, but how much further can it go? Long-term, Sasol has good fundamentals, is developing Cracker in the U.S., and we expect the industry to recover. Good news for the industry is that the costs are going down, so margins can be re-established (perhaps not fully), and the margins can be held by the dropping costs.
So the time to sell Sasol would have been at R600.00/share, and not the current R400.00. You’ve said that you can expect the supply glut to exist for a while longer?
Yes. Production is going to increase in 2015, so there’ll be more supply. The positive thing for the market in terms of oil and gas production is that there’s a natural depletion curve. A field never produces flat for 20 years. The peak production is at beginning and then it drops slowly, between five and 12 percent per annum. If you stop drilling new wells now then naturally, production will drop. It’s not that supply will increase, but production will decrease naturally because people are stopping drilling. That will rebalance the market.
Just one last question: we had an opportunity in South Africa to really, have a look at the shale exploration here. Shell said they would put $250m behind it. We dilly-dallied as a nation. Is that off the table now? Do you think that Shell will still be exploring there?
Long-term, yes. Obviously, in the short-term people re-evaluate their exploration budget so people re-prioritise where the quickest return is, but I think that in the long-term, if the amendment (the MPRDA) is positive to an industry, there will be interest. For example, you can see governments are trying to review their tax for upstream oil and gas operations, to make those operations profitable again. If the South African government comes up with an attractive regulatory and fiscal framework for upstream oil and gas exploration, people will come back at some point in time.
That was Claude Illy, the leader of Sub-Saharan Oil & Gas M&A Advisory at Deloitte.
