In a recent interview by David Fessler of Investment U, former Shell Oil President John Hofmeister discusses his thoughts and outlook on what to expect in the coming months with regards to the drastic dip in oil prices. Though speculation and opinions range from prices hitting a low of $20/barrel to a high of $200/barrel, Hofmeister presents some interesting arguments for discussion.
In summation, Hofmeister talks of a supply surplus because of lower demand and world growth. It’s not that demand is failing to increase, it’s just doing so at a slower rate. Forecasts showed that growth would be somewhere in the range of 3% by 2015, but reports now show demand at 92 Million barrels of oil per day instead of the projected 93-94.
The oil industry was quick to react, which not only resulted in drastic labor cuts, but also a substantial decrease in operating rigs by approximately 1/3 over this time last year. Why we are still seeing an increase in production, it will eventually tail off as a result of industry cuts.
Hofmeister goes on to question the rationale behind how an approximate 1% surplus could result in a 50% price reduction? Some analysts say the sell-off was premature, but it doesn’t take a financial analyst to conclude that a drastic cut in prices might soon result in a dramatic swing of the pendulum in the opposite direction … and here’s why!
As we approach stabilization in the coming months, it might be necessary to dip into reserves to offset decreased production and the (rarely mentioned) depletion rates of conventional and unconventional wells. The reality that people fail to understand is that oil wells yield less every day; hence the term, “a depleting natural resource.”
The oil industry can control how much to cut back by way of lay-offs and the removal of rigs, but it can’t control how supply will be affected by mother earth’s natural depletion curve. Just as it will take months to see the affects of industry cuts, it could take considerably longer to deploy rigs put out of operation and catch up to the slower, but continuous growth in demand.
There are a lot of moving parts to consider with this theory, and this is in no way a definitive declaration of what will happen. It does, however, provide good insight to the question, “What if?”
Click below for a transcript of the interview. What do you think?