By Javier Blas
It’s a puzzling mismatch. The oil industry believes it is underinvesting in future production capacity, creating the risk of future shortages and higher prices. Yet long-dated oil prices keep falling, sitting now at $65 a barrel and suggesting the market expects spending would be more than enough to avoid a gap. Either the industry is wrong — or the market is.
My bet is that both are somewhat wrong. I’m not trying to hedge my view, but it looks like the industry is exaggerating its alarm about investment. Still, if I have to choose a side, I would bet against the market. Long-dated oil future prices appear too low right now. More is at stake than billions of dollars of oil investment in new projects, or wagers in the futures market. If the industry is right, it would mean higher prices in the second half of this decade, potentially fueling fresh inflation in the global economy.
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The incongruity between the industry and the market was in full display last week at the annual CERAWeek, the world’s biggest energy conference, which attracted more than 7,000 delegates to Houston.
From Darren Woods, the boss of Exxon Mobil Corp., to Wael Sawan, the new chief executive officer at Shell Plc, everyone warned about underinvestment. “This is a depletion business,” Woods told the conference. “Investment has been lower than what’s needed.” Last year, the oil and gas industry spent $499 billion on production, according to the International Energy Forum, a body that promotes dialogue between energy producing and consuming nations. If the industry is to meet future oil demand, the IEF estimates that spending would need to rise to $640 billion by 2030. But the guidance from companies suggest such an increase isn’t on the cards.
The investment-is-too-low-to-meet-future-demand message was accompanied by warnings about rising oil prices in the future. But in Houston, investors were largely unconvinced. From equity to commodity managers, there was a collective shoulder shrug. One veteran investor, with decades of CERAWeek meetings under his belt, warned me: don’t second-guess the market.
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First, a word of caution about forward oil prices. The futures curve is not a forecast of where commodity prices are heading but rather a snapshot of what the market is willing to pay today for delivery in the future. Today, the market is willing to pay just $65 a barrel for delivery of a barrel of Brent crude in five years — falling below the 10-year average for that benchmark. If one wants to buy a barrel for delivery in December 2024, that rises to $74 a barrel. The very same barrel, bought on the spot market for immediate delivery, costs about $82.
If investment isn’t coming, why are long-dated prices not higher?
Oil investors appear convinced the future balance between supply and demand would not be as tight as the industry is warning. First, investment recovered significantly in 2022. And oil companies, flush with cash, are set to lift spending even higher in 2023 and beyond. Second, Russian oil production hasn’t collapsed as feared due to Western sanctions. That in turn means that the world won’t have to replace low-cost Russian output with higher-costing production from elsewhere. Third, many investors believe that oil demand will slow over the next two to three years, from an historic average of about 0.8 to 1.2 million barrels a day to as little as 0.3 to 0.5 million barrels a day.
Yet, those factors alone don’t appear to fully justify the five-year forward for Brent trading at 20% discount to spot prices. For one thing, the recovery in headline spending reflects increased costs for machinery and parts. In nominal terms, spending has increased significantly less. And even at current rates, spending would need to increase another 30% to ensure enough supply by 2030. For now, hopes for a significant slowdown in demand growth remains just that — hope. Oil consumption is growing in 2023 at double the typical annual rate, and the early forecasts for 2024 also point to a further acceleration.
The bowels of the oil market offer a more convincing explanation for the most recent drop in long-dated oil prices. In recent weeks, the cost of hedging has declined, allowing shale companies to lock-in prices by selling forward. The concentrated wave of hedging has pushed down prices, particularly for 2024 and 2025, depressing longer-dated prices even further. That’s a one-off factor that is likely to dissipate soon — which will further complicate the inflation outlook and make life even more difficult for central bank policymakers.
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Spot oil prices will continue to fluctuate in the next few months, pushed up and down by concerns about a hard or soft landing for the US economy and hopes for strong reopening of China. But long-dated oil prices are poised to rise.
© 2023 Bloomberg L.P.
