Don’t crown the US the new ‘swing producer’ in oil just yet

The CERAWeek conference, just held in Houston, was a feast of views on the energy industry. The organizers listed 648 speakers over five days, ranging from government ministers and senators to CEOs of majors and large independent companies and think tank experts.

Most of us attending had a slice of that big pie, and each person may have had a different takeaway. Such is the nature of the industry.

{mosads}Although the theme was “Energy in Transition,” the underlying focus was on industry disruptors — past, current and prospective — and some prevailing views ought to be challenged.

It has become conventional wisdom that the U.S. is now the “swing” producer in the global oil market, taking over the role that OPEC created for itself almost 50 years ago. U.S. production has grown dramatically over the last decade as a result of the so-called fracking revolution. 

Leading analysts, like the Paris-based International Energy Association, expect that growth to continue on a steady trajectory. They cite many bases for that view:

• America’s abundant resources;
• existing infrastructure and the ability to add more;
• financial resources that may grow as overseas profits are repatriated;
• an increasingly friendly regulatory environment and technology that has driven down costs;
• increased production; and
• smoothed-out wrinkles along the entire value chain.

At least one industry leader, Mark Papa, challenges the assumptions about sharp growth of production. He has a track record that makes his words count. At the failed Enron Corporation, his Enron Oil and Gas division made money. The successor company, EOG Resources, was almost in a league of its own for consistently fine performance.

Now in his third act in the industry with a newly-formed independent, he argues that geology itself is a constraint, investor demands have sharpened and technology is being oversold. That’s worth a hearty debate among technical experts to inform the policy debate.

This goes to the heart of energy markets: Who is the swing producer and how will they act? As U.S. production grew rapidly after 2010, it contributed to a surplus over world demand. It was a small fraction — less than 2 percent. But commodity prices can swing wildly as supply chases demand. 

That meant that prices plummeted from over $100 a barrel (with some optimistic analysts projecting $200) to less than $30 for a while. That took a toll on producers, service companies and their bankers from the Middle East to Nigeria, Venezuela, Texas and North Dakota.

“Lower for longer” became the new mantra, but with fingers crossed in hope of higher prices. Those prices came after a nearly three-year drought by the end of 2017. By then, hundreds of thousands of people had been laid off worldwide, hundreds of companies took some form of bankruptcy and governments stared at shrinking treasuries. 

Current oil prices in the $60-65 range, with more variation depending on quality and location, have resulted in some sense of stability, however tentative. Capital investing is resuming, in part funded in the U.S. by repatriated overseas profits, but not to levels at the peak. 

But costs have dropped dramatically because of technology — much at the field level — and tough negotiations with service companies.

Maybe it’s time to explore a very different scenario — that the U.S. is becoming the base for global production — not the swing producer — and that base is growing; the argument is just over how much and how soon. There is no mechanism to control U.S. production outside of market forces.

Other producing countries will have to accommodate by restraining their production until world demand is very robust. Yet, most long-term projections are for declining liquid fuels. This would mean intense competition for the few growing markets, especially in Asia.

Saudi Arabia is in a unique situation that requires strong prices for the medium term. That is because Saudi Aramco is working to float a massive initial public offering of shares, reportedly for about 5 percent of its reserves.

While it is unclear how the deal will be structured, the valuation turns on investor expectations of oil prices. To support prices, Aramco disproportionately cut its own production during 2017.

How long Saudi Arabia, the rest of OPEC and Russia will do that remains uncertain. They may no longer control global production, but they still have the “lose-lose” option. They still can increase production and drive prices to very low levels. That might be more visceral than logical, but this is a strange environment.

As a result, some investors hesitate to invest in the seemingly rejuvenated U.S. market, and this dynamic will continue to keep oil executives here in the U.S. and around the world awake at night.

Bill Arnold is a professor in the practice of energy management at Rice University’s Jones Graduate School of Business. Previously, Arnold was Royal Dutch Shell’s Washington director of international government relations and senior counsel for the Middle East, Latin America and North Africa.