In the current climate, the vast majority of worry in the oil markets surrounds the huge imbalance in supply and demand in the industry. This is understandable, given that the enormous glut of oil in the markets has pushed prices down from more than $100 around two years ago, to less than $50 right now.
However, in a major new research note, HSBC argues that soon we won’t be worrying about there being too much supply and not enough demand, but rather, things will be the other way round soon enough, and that is going to cause huge problems.
In the report from HSBC staff Kim Fustier, Gordon Grey, Christoffer Gundersen, and Thomas Himboldt argue that given the finite nature of the physical amount of oil in the world, people should really be paying more attention to falling supply in the future, rather than oversupply right now.
Here is the extract from Fustier et al (emphasis ours):
“Given the backdrop of the past two years’ severe oversupply in the global oil market, it’s not surprising that few are discussing the possibility of a future supply squeeze. Indeed, most of the current debate on the long-term outlook for oil seems focused on risks to demand from progress on both the policy and technology fronts.
“Meanwhile, we expect the past two years’ severe crude price weakness to result in a return to balance in the global oil market in 2017. At that stage, we expect global effective spare capacity to fall to as little as 1% of demand. Supply disruptions have had only limited impact on price in 2015-16 due to the global oversupply, but the market will be much more susceptible to interruptions post-2017. In addition, given the almost unprecedented fall in industry investment since 2014, we expect the focus to return to the availability of adequate supply.”
HSBC’s note is more than 50 pages of detailed, thoughtful research on the state of the markets and how the dwindling availability of oil, along with jumping demand over the coming decades will change the world.
But included within the report is a helpful, ten-point summary of the key arguments the bank makes, and what is going on right now. We have summarised the arguments below:
- Oil’s oversupply problem, which has caused most of the trouble in the markets in recent years will end by 2017, and the market will return to balance.
- Spare capacity will have shrunk substantially by then “to just 1% of global supply/demand.” This HSBC argues, will make the market more susceptible to disruptions like those seen in Nigeria and Canada in 2016.
- “Oil demand is still growing by ~1mbd every year, and no central scenarios that we recently assessed see oil demand peaking before 2040.”
- 81% of the production of liquid oil is already in decline.
- HSBC sees between 3 and 4.5 million barrels per day of supply disappearing once peak oil production is reached. “In our view a sensible range for average decline rate on post-peak production is 5-7%, equivalent to around 3-4.5mbd of lost production every year.”
- Based on a simple calculation, HSBC estimates that by 2040, the world will need to find around 40 million barrels of oil per day to keep up with growing demand from emerging economies. That is equivalent to over 4 times the current crude oil output of Saudi Arabia.
- “Small oilfields typically decline twice as fast as large fields, and the global supply mix relies increasingly on small fields: the typical new oilfield size has fallen from 500-1,000mb 40 years ago to only 75mb this decade.” — This will exacerbate the problem of declining oil fields, and the lack of supply.
- The amount of new oil discoveries being made is pretty small. HSBC notes that in 2015 the discovery rate for new wells was just 5%, a record low. The discoveries made are also fairly small in size.
- There is potential for growth in US shale oil, but it currently represents less than 5% of global supply, meaning that it will not be able, single-handedly at least, to address the tumbling global supply HSBC expects.
- “Step-change improvements in production and drilling efficiency in response to the downturn have masked underlying decline rates at many companies, but the degree to which they can continue to do so is becoming much more limited.” Essentially HSBC argues that companies aren’t improving their efficiency at a quick enough rate, meaning that supply declines will hit them even harder.
Here is the chart showing the decline in production post-peak:
All these concerns combined, HSBC argues, means that we should be less worried about the current tilting of the oil market to oversupply, and more towards the coming decline in supplies. It may not hit us for a while, but it is a looming crisis that the oil industry must face.
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