September 15, 2016

For those who believe the oil market will eventually confront a supply crunch because of the unprecedented collapse in capital expenditure over the past two years the International Energy Agency’s investment report provides plenty of ammunition.

“There is evidence that cuts in exploration activities have already resulted in a dramatic decline in new oil discoveries, dropping to levels not seen in the last 60 years” according to the report which this week detailed the decline in investment in oil and gas projects since 2014.

And there is more good news for the oil bulls.

“The total fall [in capex] exceeds $300bn over the two years — an unprecedented occurrence”, the report goes on. “Furthermore, there are no signs that companies plan to increase their upstream capital spending in 2017.”

However, the eye-catching retrenchment is not the only story the report tells.

The current decline in spending follows a massive investment binge between 2011 and 2014, when oil prices held above $100 a barrel. In those years, annual upstream oil and gas investment averaged more than $700bn as the lofty level of crude made all sorts of projects viable.

And the repercussions of that investment splurge are still being felt.

Thanks to the long lead times for complex projects given the green light during the period, many are only now coming on stream. That is adding oil to a market already awash with it. Until now, the effect of these supply additions has been largely overlooked even though they could delay the long-awaited rebalancing of the oil market. But that is changing.

This week the research arm of Opec, the production cartel, revised up its oil supply forecasts from non-member countries for this year and 2017. Among other factors, it cited higher than expected output from Norway as well as the start-up of the long-delayed Kashagan field in Kazakhstan.

This hangover from the investment binge has also been examined by JBC Energy, a Vienna based consultancy.

In a report titled “Short-term supply wave to spoil the rebalancing party” published early this month it reviewed 99 new upstream projects and supply additions with start dates between January 2015 and December 2017. There were some surprising discoveries.

It found the developments in places such as the Gulf of Mexico, Canada, the North Sea and Russia will add 5.2m barrels a day of gross capacity to the market.

Of course, more capacity does not necessarily translate into more supply. This is especially true for oil because new streams will be offset by falling production from more mature fields. But even assuming an annual decline rate of 4.2 per cent, JBC reckons the new projects could add 2.7m b/d of net supply to the market — a large chunk of it coming in the not too distant future.

“News headlines on supply developments gyrate around US shale developments, Opec policy, supply outages, budget cuts, the delay or cancellation of long-term projects, and occasionally decline rates,” says JBC. “What has fallen through the cracks a bit is the relatively stable amount of new supply already being ramped up or planned to come online.”

If JBC has got its projections correct on the 99 projects, it means two things, neither of which is particularly bullish for oil. Inventories will probably continue to build next year. And the market could be even more oversupplied in the first half of 2017 than it was in the same period this year, when prices slumped below $30 a barrel to a 12-year low. They are currently around $45 a barrel.

In fact, the glut could get worse if two Opec crude producers whose supplies have been disrupted by internal conflicts — Nigeria and Libya — are able to overcome their problems and start adding barrels to the market. And this week brought news that several oil terminals in eastern Libya could be reopened if a deal between a rebel general and the country’s national oil company is made to work.

None of this is to say that the record decline in spending over the past two years will not have an impact over the longer term, especially if demand growth continues to average more than 1m b/d. The oil market remains a cyclical beast that will throw up further surprises.

For the moment, however, the market looks increasingly well supplied.

“Our project ramp-up analysis suggests that massive additions are due over the next seven months, questioning not only any upside to oil prices but even suggesting further downwards pressure,” cautions JBC.

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