LONDON (Reuters) - Oil prices are likely to average less than $60 per barrel across the next cycle to ensure production, especially from the shale sector, remains in line with the slow increase in consumption.
On Monday, BP announced its long-term investment appraisal price had been cut to an average of just $55 per barrel for Brent in real terms between 2021 and 2050.
Explaining its decision, the company cited the lingering impact of the coronavirus epidemic on oil consumption and the potential for an accelerated transition to a lower-carbon economy and energy system.
“These lower long-term price assumptions are considered by BP to be broadly in line with a range of transition paths consistent with the Paris climate goals,” the company said in a press release.
But the reduced forecast also recognises prices above $60 per barrel are not sustainable for long because they encourage too much production, particularly from the United States, outrunning consumption growth.
Russia’s oil producers, too, seem to have concluded long-run balance requires Brent prices below $60, perhaps even as low as $50, to maintain their market share.
By contrast, Saudi Arabia and some of its close allies still seem to be targeting prices well above this level, perhaps $70 or more, reflecting their short-term revenue needs.
That price gap between Russia and Saudi Arabia caused the breakdown of the original OPEC+ output agreement earlier this year and led directly to the outbreak of the brief volume war in March and early April.
For now, the two major oil exporters have called a truce as they deal with the epidemic’s unprecedented hit to consumption.
Political pressure from the United States, where shale producers were caught in the cross-fire, has also forced an armistice.
But the basic production and consumption conditions which triggered the volume war have not disappeared and tensions will re-emerge in the next few years if oil prices climb above $60.
Saudi Arabia and its closest allies may have to accept $50-60 rather than $70 or $80 as the maximum sustainable price and plan their budgets and production accordingly.
U.S. petroleum production increased at an average rate of 8-11% per year over the decade from 2009 to 2019, according to the U.S. Energy Information Administration and BP (tmsnrt.rs/3d9bgDT).
Production in the rest of the world increased at an average rate of just 0.3-0.6% over the same period (“Short-Term Energy Outlook”, EIA, June 9, and “Statistical Review of World Energy”, BP, June 17).
The result of this unequal growth was that the U.S. share of global petroleum production doubled from 7-11% in 2009 to 15-19% in 2019.
The EIA and BP present a range of estimates for production, depending on the treatment of natural gas liquids, biofuels and refining gains, and whether measurement is by volume (barrels) or mass (tonnes).
But every definition shows U.S. production growing much faster than in the rest of the world and doubling its market share over the last decade.
On every definition, U.S. production has also grown much faster than global consumption over the same period, which has risen at an average rate of just 1.4% per year since 2009, according to BP.
As a result, U.S. oil producers have captured between two-thirds and three-quarters of all the growth in global oil consumption over the last ten years, leaving little for other countries.
In the early years of the shale boom, when it was still a relatively small part of the global market, U.S. oil production could grow faster than output from rivals and global consumption.
Now its market share has reached 15-20% of global production and consumption, however, U.S. shale can’t continue to do that without putting pressure on rival producers and prices.
In a complex system, like the oil market, a major component cannot grow faster than the whole, without eventually disrupting the overall stability of the system.
U.S. production has grown faster than output in the rest of the world and global consumption every year since 2009 – with the exception of 2016. It has grown faster whenever Brent prices averaged $64 or more in real terms, the exception again being 2016, when prices averaged just $47 and U.S. output fell.
In reality, production changes tend to lag price changes by up to 9-12 months, so the fall in output in 2016 was partly attributable to lower prices in 2015 as well.
Monthly average prices dipped below $60 in August 2015 and did not rise above this threshold again until November 2017.
Empirically, $60, or perhaps a few dollars per barrel lower, can be identified as the critical price threshold in the oil market over the last decade.
Following a decade of strong growth, the United States together with Saudi Arabia and Russia now accounts for more than 40% of all global petroleum output.
To ensure production grows in line with consumption, and is shared equitably and sustainably among the three top suppliers, oil prices will likely have to average $60 or less over the next price cycle.
Prices have always been cyclical, so in the next few years, there are likely to be extended periods when the price moves significantly above this level, matched by periods when prices are much lower.
But BP’s investment appraisal price assumption of $55 seems a reasonable forecast for the through-cycle real average price over the next decade.
(John Kemp is a Reuters market analyst. The views expressed are his own)
Editing by Kirsten Donovan