Reva Bhalla: Hello, my name is Reva Bhalla and today I am joined by our Global Energy Analyst Matt Bey to discuss the geopolitical implications of below $90 per barrel oil. Matt, thanks for joining.
Matt Bey: It's good to be here.
Reva: So, let's start with the supply side. What are the structural factors that you see underpinning what could be a very protracted slump in the price of oil?
Matt: So the United States has really increased its production quite dramatically over the last two to three three years. It has actually increased it by the size of the Organization of the Petroleum Exporting Countries (OPEC) members about two and a half to three million barrels per day. Today it is sitting around nine million barrels per day, which is third only to Saudi Arabia and Russia. That growth is still going to be happening, even if the oil price stays in the $80 to $90 dollar range it is right now. There is still a lot of production that is still going to be quite profitable in the United States and there is still going to be drilling. We have actually seen the rig rates in the United States kind of stay the same and that is really going to keep continuing to drive, maybe even adding another million barrels per day by the end of next year, which will continue to add pressure on the oil price. Outside of the United States we have had Libya come back in a big way thanks to having solved some of their structural issues within the political landscape of the country that had prevented oil exports earlier this year.
Reva: Well, yes and no, right? Libya, I would say is sort of the swing player here in that a lot things have sort of come together to allow production to stabilize to a certain degree. What did they increase from the beginning of the summer? What percentage of increase are we looking at?
Matt: In percentage terms, about 300 percent. They have almost tripled it. The landscape there is very tense, the militants are still fighting one another. They still have the same kind of reasoning to block oil exports, it is just that right now they are not doing that. Going forward, that is something that is probably going to continue. Libya is probably not going to sustain itself for a very long time. And in the future, probably even as soon as next year at some point, we will start to see some of that oil fluctuate up and down.
Reva: And that is the key there to follow all of the myriad militant factions in Libya. They are busy right now fighting each other. General Khalifa Hifter is leading a force in the east, you have this array of Islamists in Tripoli and as long as they are focused on each other that is good for oil but that can flip very easily, especially as both sides try to undermine the other's gains in that wider battle. So, Libya is definitely not a sure thing.
Matt: And that is also something that investors and people who do watch the oil markets very closely are well aware of and they do keep a very close eye on what Libya is doing up or down and then bet accordingly.
Reva: So, what else on the supply side? You think that U.S. production will continue proceeding apace, we are at the nine million barrel per day mark, essentially. Of course now when we look at this coming OPEC meeting in November all eyes are on Saudi Arabia. What is Saudi Arabia thinking?
Matt: Right now Saudi Arabia is thinking that they do not want to cut production. They have done it in the past and they have actually gotten burned, especially in the 1980s. In the 1980s when they did it, in 1981 they were producing ten million barrels per day, by 1983 they had dropped that to five million but the oil price actually decreased, so they did not actually get the desired effect and they continued doing so and cut their production even further by 1985. And then oil price kept on declining and they decided that this wasn't working. Since then, they have been very hesitant to actually decrease oil production.
Reva: Understandably so. So what exactly happened there? Structurally, why did Saudi Arabia not get the result it wanted?
Matt: Well, in the early 1980s a lot of the developing world was in the Latin American crisis for example, a lot of the developed world was still also in economic crisis, especially the United States, which was in recession in 1981. That allowed overall oil demand to remain lackluster. Later in the decade, you started to see production from the North Sea become a bigger impactor and overall supply was still increasing, even as Saudi Arabia was rolling back production. Now we are in a similar situation in which we do see a lot production coming online in places like the United States, so they would have to make pretty dramatic cuts. But we are also in a state where places on the demand side of things are not looking's good — Europe, for example.
Reva: Right, so in Europe and Asia, still these are huge economies, there is still a lot of demand there, but it is the rate of growth of that demand that is decreasing.
Matt: Exactly. So, in the case of Europe the demand is pretty much structurally been flatlining for about a decade or so. The same is basically true in the United States. That is something that is not going to be picking up anytime soon. Probably, it won't ever actually pick up. In places like China, though, the demand is growing and that is actually something that is going to separate the 1980s from today. Today, the developing world is much bigger in terms of raw, physical consumption. In the 1980s they were still really really small and so while they were actually growing still it just wasn't enough to move the register on the global demand side. Today it is. So that will at least allow us to avoid a scenario in which the prices continue to fall dramatically.
Reva: So in this face off between Saudi Arabia and U.S. shale, essentially, over price, who wins and is there a winner, really?
Matt: It is not necessarily who wins or loses. Saudi Arabia has never been a gigantic exporter to the United States. The United States has always been a huge producer of energy and it was as big as it is today, you have to keep in mind, in the early 1980s and 1970s at which time it was producing the same amount that it does today. The market that they are really concerned about is the foreign market in Asia, for example. While they would probably appreciate shale not actually happening in the United States, they are much more worried about it spreading outside the United States where it would begin to cut into markets that they really care about, like in China.
Reva: OK. And, so, another deadline coming up — Iran is looking toward its nuclear deadline on Nov. 24 hoping for an easing of sanctions. They are at about 1.5 million barrels per day. But even if we do have the negotiations continue, which is what we expect, we don't expect a huge influx of Iranian oil into the market any time soon.
Matt: It depends on when exactly that kind of final deal occurs that actually allows the removal of sanction and the exports to increase, but once we do have that deal you will probably see a very slow increase over the next six to twelve months, which will actually add maybe half a million to a million barrels per day. This would be significant, obviously, but the kind of plans that Iranian President Hassan Rouhani has for oil production is in the longer term to increase it to ungodly numbers like eight to twelve million barrels per day, which is much more difficult.
Reva: Which is completely unrealistic.
Matt: Well, not completely.
Reva: On the time line that we are talking about, yes, and a complete easing of sanctions is not in the cards anytime soon and there are some big political constraints.
Matt: And also if you are considering how big Iran can be in the longer term, in the five year period, it is also going to include how much interest there is from international companies to actually go into Iran and help to do the same thing that we have seen in Iraq. Even in Iraq they have not really dramatically increased their production since they re-opened to Western investment in the late 2000s.
Reva: I am worried about Venezuela. So Venezuela, strangely, pegged their budget to $60 per barrel oil — Chavez' legacy, essentially. But we know that their finances are not doing well.
Matt Bey: A lot of their off-budget financing for buying off political patronage, that is not tied into that $60 per barrel. They need that money as well for their political system to be successful. That is what is what is going to push up their break even well over $100 per barrel. That is what is now in jeopardy.
Reva: And so we are watching basically as Venezuela's finances become more severe and constrained in the coming year, the selling of their Citgo Petroleum Corp. assets is going to be a big signal. Anything, if they try to sell off their gold reserves. We are really watching that security climate in particular because if we see social unrest as a result of peak levels of inflation, it all comes down to President Nicolas Maduro to manage that. So, let's look to our neighbor up north, Canada. So, they are in a bit of a peculiar situation, especially when it comes to that price benchmark. What is Canada looking at in terms of their production?
Matt: Right now it is around four million barrels per day. They want to increase that to six million barrels per day by 2030 or somewhere around that figure. It is kind of a slow progression that is not like what we are seeing in the United States, which is much quicker. It is adding a little bit here, adding a little bit there. Canada has major projects that are 20-, 30-year projects that are coming online. And those are the ones that are a little bit more in jeopardy, but the thing that we need to keep in mind when we look at Canada is that because the pipeline infrastructure is not as developed as they would like, there are a lot of capacity and bottleneck constraints that keep them from getting the international price of oil. So they have actually been sitting at around $60 to $70 for a long time.
Reva: So, how does Canada break out of that pipeline isolation? We have all of these different proposals on the table for the Energy East pipeline or Keystone XL pipeline and we know all the political constraints. What can we expect out this pipeline debate between the United States and Canada?
Matt: It depends a lot on midterm elections in the United States and how much freedom U.S. President Barack Obama has to pass Keystone XL. Potentially, if he does not, the 2016 elections if a Republican or what kind of Democrat comes into office, those are the things that are still playing out. That is still something that is probably going to play out over the next three years. In terms of the actual Canadian debate, a lot of that is going to hinge on their elections that are coming up in 2015. Right now the Liberal Party leader, Justin Trudeau, has a little bit of a lead over the current prime minister, Stephen Harper, who is much more of a defender of the pipelines. Trudeau is much more in favor of something to the United States like Keystone XL, but is not as much in favor of Canada-based pipelines such as the Energy East one that you mentioned, or any of those to the coast of British Columbia.
Reva: The bottom line is that it is going to take a while for the politics to sort out. In the meantime that means a lot of stress on rail for transport for Canadian crude oil.
Reva: Well, Matt, I think we are out of time, thank you very much. We will have on Monday, Nov. 3, a series on the geopolitical implications of below $90 per barrel oil that covers all of the regions that Matt Bey has led here at Stratfor. We look forward to you checking that out and thank you for your time.