21 Sep When BP Calls The Bull Oil Party Over
In a startling announcement last week, BP called peak oil demand here (well, either here now or perhaps last year, or in just a few months). Brace yourselves for the fall out.
Not For The First Time
My favourite source of energy statistical data and publisher of an annual scenario analysis of the future of energy released a startling statement last week, and this analysis will reverberate throughout the energy world for months if not years.
There are a handful of reputable energy statistics agencies and bodies around the planet. I like the International Energy Agency (IEA in Paris), and not just because I was invited to their offices to contribute to one of their studies. The agency is stuffed with PhDs and mathematicians crunching the numbers. The US-based Energy Information Administration (or EIA) is a US government body tasked with largely the same mandate. OPEC data is also very valuable, although I find not quite as consumable as its peers.
But I turn to BP’s annual statistical review of energy over and over. It’s clear, consistently presented, expansive and easy to consume. It’s quite probably my most widely referenced source for energy data. To be fair, I spend most of my time in the oil and gas pages, and rather less in the coal and nuclear sections. But in the shadow of BP’s announcement, I may need to rethink that strategy.
BP’s modelling across a handful of likely scenarios of the world of energy are pointing to flat and declining global demand for oil, which has prompted BP to embark on a fresh strategy to reduce its exposure to oil. Earlier, Shell announced a similar plan (a reorientation of resources to new energy), but without the hammer statement of peak demand.
I recall almost two decades ago when BP rebranded itself with its new sunflower logo and catchy handle “beyond petroleum”, which translated into exactly nothing strategically. There is a risk that BP is again ahead of itself, that we’re far from peak demand, and that the world will soon go on as it has. After all, there are 1.2 billion combustion engine cars out there (I have one), 300 million heavy trucks (I don’t have one of those), 50 thousand military and commercial ships, 30 thousand airplanes, and they’re all pretty much useless unless they are in motion, which requires petroleum.
Almost all products (except perhaps air and water), go through a demand S-curve, where demand peaks and product demand slips into decline, but oil is not the same as CD players, flip phones and boom boxes. Petroleum is deeply entrenched in our way of life.
The Public Responses
I’m certain many oil companies, suppliers to the industry and nation states dependent on oil are now mobilising consulting studies and board meetings to discuss BP’s position (in fact, I’ve been invited to share my views to a Board in October). Some of the possible responses I’ve come to expect:
- Some will studiously ignoring BP until they can formulate their own statements to manage their investors, employees, and communities.
- Some will dismiss the research as just “one man’s opinion”, and highlight all the tricky assumptions in the analysis that could yield a different answer.
- Some will suggest the analysis is self-serving. They point out BP’s track record of climate and change mis-steps, its ill-timed rebranding 20 years ago, its much publicised problems in Russia and the Gulf of Mexico, and its new management needing to break with the past.
- Some will pretend everything is fine, arguing as I have already that the huge structural demand that drives the sector is hard to change and will be enduring.
- Some will count on today’s hyper news cycle to push this story down the reading stack in the hopes that it will simply disappear.
- Some will be heartened by China’s claims that demand has come back. Surely this is evidence that society wants to return to business as usual.
- Some will be content to play wait and see. It’s too soon to draw any firm conclusions. Of course, auto executives said the same thing about Tesla a decade ago, and retailers everywhere ignored Amazon too.
Sometimes the industry is like a duck on water—all appearances are of languishing placidly on a lightly rippled plane, but just below surface the legs are flailing chaotically to maintain course.
Managing the Fall Out
In the commodity oil industry, the price of the product is set by the marginal barrel. That is, when all demand but one barrel is fully supplied by the market, the buyer of that last barrel will pay a little more to get it, and in so doing, lift all prices at least a little. I find it hard to detect this phenomenon.
Similarly, the marginal barrel sets the price when the market is over supplied. In 2014, as the US was ramping up its shale plays, the market swung into oversupply by a mere 1-2% (or between 1 and 2 million barrels per day). That oil was conveniently tucked away in storage, but once storage was full, the holder of the marginal barrel with no customer will practically give it away, causing short prices to collapse for everyone (unless there is some kind of curtailment of supply).
We saw this play out again with stark consequences this year when Saudi Arabia and Russia both decided to flood the market with their oil in the face of the demand collapse caused by the pandemic. Prices promptly fell, and in some markets under some circumstances, prices went negative altogether, with suppliers paying customers to take the product.
Read more on contango markets from my article in April.
Alberta has on occasion imposed curtailments on its suppliers to remove the marginal barrels from the market.
If BP is largely correct, we are now, globally and much faster than planned, heading into a world that is structurally overbuilt for the demand, with the price of the product to be set by the marginal barrel. Not good. Not good at all.
The problem is that oil producing states (Texas), provinces (Alberta) or nations (all of OPEC, and Russia), save perhaps Norway, cannot deliver a managed market, and individually are overly dependent on the riches thrown off by the most profitable global commodity that has been in perpetual growth mode for over 100 years (a very long S-curve). There is no incentive, and in fact, substantial disincentive, to try to manage supply to the demand.
Here are just some of the consequences that could unfold in the coming weeks and months.
Structural advantage will favour the low cost producers. That might not be OPEC, whose members are highly dependent on high oil prices to balance the national treasury. There is space globally in the market for low cost players everywhere. Upstream portfolios will be quickly reconfigured leading to a wave of transactions.
Capital markets will price BP’s view into their expectations for share value accretion and future dividends, which will further depress oil company stock prices. Capital for growth and expansion will be harder to secure for those producers outside of the national oil companies, and for those without a compelling story about cost leadership.
Oil companies will have to truly high-grade their projects, and only the very best, with the fastest time to market, the lowest capital cost, the highest reliability, the lowest operating cost, the least impactful on the environment, and the highest possible production will be sanctioned. Everything else is at risk of being mothballed or stranded. Boards will see that shareholders are protected. This is a good thing.
Existing production is now on notice. Prepare to be shut down, sold off, or run out, unless there is a plausible plan and meaningful measurable action to become the low cost asset. This applies to basins, wells, and facilities throughout the entire value chain. Even gas stations will need to transform or consolidate. Managers everywhere should take this as “we are now on war footing” with our costs and productivity.
The oil industry survival playbook has largely run its course because of the pricing collapse in 2014, and the pandemic, but it will be a great time to be in Procurement. You’ll be put back in charge to relentlessly squeeze the supply chain.
Traditional suppliers to the industry (engineering firms, equipment companies, consultants), whose services reflect the commodity price, will need to find new sources of revenue as capital projects vanish, and cost pressures everywhere else pinch margins. This should trigger a wave of fresh innovative thinking about the industry, galvanised by successful changes introduced during the pandemic.
Employees in the industry will now rethink their life choices. Career prospects may be ok for now, but what about the future. Those who have left will feel vindicated. Mature individuals will be content to just wait it out, but their options and stock exposure to the industry should call out for attention. The biggest worry is that the talent pipeline influencers (parents, school counsellors, Instagram, Greta), will more firmly steer youth away from the sector. The fall-out will show up in five short years. Leaders will need to redouble their efforts to keep their people in the game, and will need a much more positive story to tell.
Check out this clip from Amazon about energy. Yes, the world’s largest companies are now coming for your market.
Rentier state governments will need to fundamentally and urgently rethink their economies as revenues from the industry experience a double fall (reduced volumes and lower royalties because of the lower price). Lower tax revenues mean weaker schools, poor healthcare, and imperilled retirements.
Short countries (that is, importers of oil), will revisit with renewed interest any green plans. Continued investments in import infrastructure will look like stranded money.
Anyone with a story to tell about cost removal from this industry is going to get a huge boost. By far the biggest winners will be those with digital innovations that work to take out cost. The pandemic has shown the industry how to change fast, and many companies will need to do exactly that.
When BP Calls the Bull Oil Party Over
For an industry that feels like the past 5 years would never end, BP has finally called an end to the 100 year long bull oil party. Brace yourselves for the next party!
Check out my book, ‘Bits, Bytes, and Barrels: The Digital Transformation of Oil and Gas’, available on Amazon and other on-line bookshops.
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