Is Market Heading for Supply Crunch?

Fears of a post-2022 supply crunch in oil markets are mounting in some corners of the industry, but are they warranted? The concern is that years of weak upstream investment will be felt just as a slowdown in US shale production takes hold, resulting in a supply shortage and potential price spike. The outlook for future investment looks bleak, too, as Covid-19 has magnified the forces that caused producers to slash capital expenditures in the first place. Still, a supply crunch is not certain in the medium term since it assumes oil demand will return to old patterns in a post-Covid-19 world (PIW May1'20). Lower oil prices, tighter credit conditions, and an unwillingness to invest in non-Opec megaprojects factored in the sharp drop in upstream spending in recent years. But demand uncertainty was the common denominator, and Covid-19 has heightened this risk. Global upstream spending never recovered from the last price downturn in 2015-16. It totaled about $500 billion in 2019, down roughly $300 billion from the peak of almost $800 billion in 2014, according to the International Energy Agency (IEA). The agency expects that 2020 outlays dropped 33%, putting them around $338 billion, while Energy Intelligence sees a further 7% drop in 2021 (related). It's hard to envision a supply deficit now, with the pandemic still pummeling demand and Opec-plus -- excluding Iran -- holding back 7.8 million barrels per day of production to balance markets (related). But the IEA and Opec were alarmed about weak upstream investment levels in 2018 -- before the pandemic and when US shale was booming, delivering annual growth of around 1 million b/d (PIW Jun.26'20). Even with all the spare Opec-plus capacity and massive inventories, some say a significant supply deficit is inevitable, with the only question being its magnitude. Both the IEA and Opec believe another 27 million to 30 million barrels of oil equivalent per day of capacity will be needed by 2022 to close the gap between projected production declines and demand. The figure jumps to 68 million boe/d by 2030. Both estimates assume modest recoveries in demand -- below the historic average of 1.2 million b/d per year. The Saudi Arabia-based International Energy Forum (IEF), an organization of 70 energy ministers, says upstream capex must rise over the next three years by 25% annually from 2020 levels to "stave off a crisis" and "substantially greater sums will be needed by the end of the decade to ensure sufficient production to guarantee market stability." Consultancy Deloitte reckons the industry must invest more than $525 billion annually just to replace annual consumption and offset average natural field decline rates of 6%-7%. A Deloitte survey of energy executives showed that 33% see a high risk of a supply crunch over the next five years. Much hinges on post-Covid-19 demand. Because of the accelerating energy transition, this is no ordinary market cycle. Indeed, if a crunch and price spike materializes, it could hurt the industry's long-term prospects should policymakers and consumers respond by moving away from oil faster (PIW Jul.3'20). Most experts, including the IEA and Energy Intelligence believe oil demand will return to pre-virus levels of 100 million b/d in the 2022-23 time frame and then resume only modest growth before peaking later in the decade or around 2030. Opec is more bullish, seeing about 10 million b/d of further growth to 2040, while BP's business-as-usual case sees demand broadly flat at around 100 million b/d for the next 20 years. Besides tepid demand, there are other factors working against a supply crunch. More production comes from less investment these days due to cost-cutting and efficiency gains. A focus on short-cycle projects, led by US shale, also means shortened timelines to first production, and markets may be underestimating shale's potential again (PIW Dec.18'20). Companies are also investing more in smaller projects near existing infrastructure, which allows output to hit the market faster, while decline rates may be overstated (PIW Jul.19'19). As such, few see a price super spike like 2008 or a prolonged return of $100-plus oil prices. But IEF still believes higher investment will be needed in a flattish demand market -- it says 51 million boe/d of new capacity will be required by 2030 even if demand peaks that year. IHS Markit Vice Chairman Daniel Yergin acknowledges that capex cuts have been “very big” but says the nature of the global economic recovery after Covid-19 will determine whether there is a crunch “more than anything else.”