Oil bulls and bears fight it out

The so-called ‘green revolution’ is seeing developed nations turn to alternative energy to power a transformation of the environment and their economies. But Opec thinks it can still sell oil.

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  1. Charles Stanley

This week's meeting of Opec, which was to be followed by a meeting of the Opec+ group, went badly awry. Instead of reaching agreement on the Saudi-led proposal to continue production cuts through the first quarter of 2021, the Opec meeting ended in disagreement, with the Saudi chairman offering his resignation. A counter proposal from the UAE, said to be backed by non-Opec memeber Russia, split the group with its suggestion of a smaller cut. There were also arguments about enforcement.

The wider group of Opec+ is now scheduled to meet on 3 December to see if agreement can be reached, subject to the informal talks which are continuing. There is probably agreement that the pace of world recovery from the pandemic, as vaccines are rolled out and colder weather hits the Northern hemisphere, would not be sufficient on its own to hold up oil prices without a further period of supply restraint. This gets difficult the longer it continues.

The cartel also has to contend with some increase in Libyan production and a pickup in the US after the hurricane lockdown in October. One of the outstanding issues causing trouble is how far countries should be required to make up for overproduction in the past by more restraint in the future – and whether this can also relate to Russia which has exceeded its limits.

We may see an agreement in the end, but this is a reminder that Opec no longer has the power it once had. Cartel members control less than 40% of the world’s oil, so they need to widen their agreement to include Russia and other non-Opec players. It also has to contend with the US emerging as the world’s largest producer, running a largely free market system which does not permit government control of total output.

The decision to cut 7.7m b/d out of supply this year as demand slumped was important, saving the oil market from even lower prices. Some of these cuts may well continue, as they need to do to keep oil prices higher. World inventory of oil built up by more than 1 billion barrels this year as, the supply cuts were below the demand fall.

The future of oil

Longer term, there are two conflicting views of oil's future. Those like the International Energy Authority (IEA) – which is more heavily influenced by the G20 and the views of global bodies about the decarbonisation agenda – tend to the view that we will soon see peak oil.

Those who – with Opec – see rapid expansion in the emerging world, look forward to a few more decades of growth in oil and gas exploitation. These produce very different outlooks for the energy industries. The IEA view will be underlined today by the speech of the UN Secretary General, António Guterres, using vivid language to demand more discipline over the journey to net zero from all states as he raises the spectre of more climate damage.

The IEA in its November report this year forecast 91.3m b/d of demand this year, rising to 97.1m next year. This compares with forecasts of more than 100m b/d for both years prior to the pandemic, with gentle growth from the 2019 levels. Instead, it expects 2020 to be 8.8m b/d required – or 9% down on the previous year.

It thinks peak oil output could come as soon as 2028, to be followed by decline as the advanced countries implement their plans to switch away from oil and gas for transport and heating. In pursuit of this view, some companies are now writing down the value of some of their oil and gas assets. Total, for example, has reviewed its holding of Canadian oil sands and made a large write-off as it expects less future output and profit from that source – with some hydrocarbons never being extracted. Companies are having to worry that maybe they will not be producing all the oil they can from identified deposits in their current portfolios.

The biggest oil reserve

How much value should the world place on the reserves of Venezuela, the country with the most proven oil in the ground at 303bn barrels?  Were there to be political change in that country to allow some rebuilding of a once important industry, the capital required would be very large, with investors querying how much of the oil will be needed and how much is now suitable for extraction.

At the opening of the Opec conference on Monday, it set out a different vision for the future. Its forecasts for 2020 and 2021, like the IEA, acknowledge a major shock to demand this year and a partial recovery in 2021. Opec expects oil demand to rise to new highs of 104m b/d by 2025, and to go upwards to 109m b/d by 2040. It reaches this higher figure by accepting a substantial decline from the advanced world – but suggesting a major improvement in living standards in the emerging world still using oil-and-gas-based technology for better and more transport and heating.

Opec claims it is buying into the G20 green agenda. It praises the circular-carbon economy idea, pledges itself to hit the Paris climate change targets – and reinforces the message of the ‘four Rs’: Reduce, Reuse, Recycle, Remove. As rich countries themselves, they are prepared to invest in solar, battery and wind energy and to support the attacks on oil – whilst still enjoying good business from selling oil and gas to lower-income economies that need it to fuel development.

Some of the oil giants also hold this ambiguous view of the world. They say they are on a journey to a low-carbon future yet rely heavily on oil and gas for their cashflows and expect oil demand at least in this decade to hold up.

The world looks set on a course of massive investment in alternatives to oil and gas. This means that investment in energy company shares that depend on fossil fuels is only worthwhile on a tactical or temporary basis, when the cycle excites markets. The weight of money and opinion behind decarbonisation in the advanced world means lower relative valuations of fossil fuel companies over the longer term – and the need to discount the possibility that some reserves will be written off rather than being an asset to harvest. It will also mean plenty of competition for the investments in the alternatives to fossil fuels.

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