Comments: The Supply/Demand Balance

Editor's column Layoffs have slowed, some companies posted profits in the third quarter, and there is even talk of a coming oil shortage that would cause oil prices to spike. But there is generally no consensus on what the oil market has in store over the next 1–2 years. At a recent industry gathering in London, Saudi Arabia’s Energy Minister Khalid al-Falih said the market was recovering from its severe 2-year decline, with global supply and demand becoming rebalanced, which will raise oil prices. “We are now at the end of a considerable downturn,” he said. But whether OPEC can reach, or keep, a production agreement is unclear. Although North American unconventional output has been unprecedented over the past few years, OPEC’s course of action over the next year “will define whether the industry will experience a slow and smooth recovery to a sustainable price equilibrium, or a period of underinvestment leading to a volatile and high oil price,” says consultancy Wood Mackenzie. “Even if the recent provisional deal produces minimal results, OPEC Gulf countries will ultimately need to cut production if operators expect prices to recover in the next 3 years.” Third-quarter company earnings were mixed, with some service companies and operators finally posting profits after severely cutting costs. Shell and BP reported third-quarter profits after shedding jobs and slashing expenses, rebounding from 2 years of losses. Both companies said they believe supply and demand are coming back into balance and expressed cautious optimism about 2017. But profits at -ExxonMobil, Chevron, Statoil, and other majors were not as positive. Halliburton finally turned the corner on profitability in the quarter but other service companies such as -Schlumberger did not. Many oil executives are warning that the lack of investment caused by the downturn will lead to a severe oil supply shortfall in just a few years and, with it, a sharp price increase. That also may suggest that they believe that the oil price recovery will be so gradual that it will not spur any rapid rise in upstream spending. But although upstream investment has fallen sharply, a supply shortage is not necessarily imminent. Much of the upstream spending that has been curtailed, says Amy Myers Jaffe, an energy expert and executive director for energy and sustainability at the University of California at Davis, was from high-cost, frontier projects such as the Arctic. With budgets tight, spending may be directed instead to surer plays such as the Permian Basin in west Texas, with a focus on existing fields, which will lead to first oil production more quickly. Investment continues to flood into the Permian, and the US Geological Survey last month upgraded its reserve estimates for the Wolfcamp shale in the Midland Basin portion of the Permian. If OPEC continues to worry about losing market share and operators become more disciplined in their upstream spending, the shortfall may not materialize.

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