The Perils of Prediction in An Unprecedented Time

Exact predictions of the future have always been close to impossible. For the oil industry today, they might be even harder than that.

Some oil companies are taking a wait-and-watch approach to planning, as multiple unknowns face the industry in a period of extreme uncertainty. Trying to predict a precise outlook right now isn’t just foolish, said Mark Finley. It could be dangerous.

“In times of uncertainty, it doesn’t pay to be too predictive. You need to be flexible and agile,” he said.

Finley is a fellow in energy and global oil at Rice University’s Baker Institute for Public Policy in Houston. He was senior U.S. economist at BP and for 12 years led the production of the BP Statistical Review of World Energy. He was responsible for the company’s long- and short-term oil market analysis and also led the global oil market and transportation-sector studies for the long-term BP Energy Outlook. Before joining BP, Finley was an analyst and manager at the U.S. Central Intelligence Agency, where he was a global energy specialist.

With the COVID-19 pandemic, “we have to remember we’re living through an experience like no one ever has before,” Finley said.

“The response of OPEC and other cooperating countries in cutting production has been like no one has ever seen before – the biggest coordinated production cuts ever,” he noted.

When the International Energy Agency released its 2020 Oil Market Report in June, it used words like “unprecedented” and “historical.”

“On the supply side, record output cuts from OPEC+ and steep declines from other non-OPEC producers saw global oil production fall by a massive 12 million barrels a day in May,” the report noted.

China’s exit from lockdown and the easing of restrictions in many other countries gave world oil demand a mid-year boost, the IEA said.

“Even so, demand in 2020 is expected to be 8.1 mb/d lower than in 2019, with the biggest declines seen in the first half of the year. Our first forecast for 2021 as a whole shows demand growing by 5.7 mb/d, which, at 97.4 mb/d, will be 2.4 mb/d below the 2019 level,” the report projected.

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Exact predictions of the future have always been close to impossible. For the oil industry today, they might be even harder than that.

Some oil companies are taking a wait-and-watch approach to planning, as multiple unknowns face the industry in a period of extreme uncertainty. Trying to predict a precise outlook right now isn’t just foolish, said Mark Finley. It could be dangerous.

“In times of uncertainty, it doesn’t pay to be too predictive. You need to be flexible and agile,” he said.

Finley is a fellow in energy and global oil at Rice University’s Baker Institute for Public Policy in Houston. He was senior U.S. economist at BP and for 12 years led the production of the BP Statistical Review of World Energy. He was responsible for the company’s long- and short-term oil market analysis and also led the global oil market and transportation-sector studies for the long-term BP Energy Outlook. Before joining BP, Finley was an analyst and manager at the U.S. Central Intelligence Agency, where he was a global energy specialist.

With the COVID-19 pandemic, “we have to remember we’re living through an experience like no one ever has before,” Finley said.

“The response of OPEC and other cooperating countries in cutting production has been like no one has ever seen before – the biggest coordinated production cuts ever,” he noted.

When the International Energy Agency released its 2020 Oil Market Report in June, it used words like “unprecedented” and “historical.”

“On the supply side, record output cuts from OPEC+ and steep declines from other non-OPEC producers saw global oil production fall by a massive 12 million barrels a day in May,” the report noted.

China’s exit from lockdown and the easing of restrictions in many other countries gave world oil demand a mid-year boost, the IEA said.

“Even so, demand in 2020 is expected to be 8.1 mb/d lower than in 2019, with the biggest declines seen in the first half of the year. Our first forecast for 2021 as a whole shows demand growing by 5.7 mb/d, which, at 97.4 mb/d, will be 2.4 mb/d below the 2019 level,” the report projected.

Finley said, “this is a demand shock. It all depends on the spread of the disease though the world population, and the medical and political response.”

At the same time, production cuts also reached historic levels. The IEA estimated a 9.4 mb/d decline in OPEC+ oil production, with output from countries outside OPEC’s reduction agreement falling by 4.5 mb/d since the start of the year.

“In the very, very short term, we had the negative price episode. The U.S. has had as much as a 2 million barrel a day decline in production” as operators shut in wells, in addition to declines due to a collapse in investment and drilling, Finley noted.

“You can’t think of it just in terms of the (demand/supply) balance. There’s still this monstrous overhang of inventory to work through. You can’t say the market is recovered fully until the inventory is normalized,” he said.

Short-Cycle Investment Emphasis

The industry entered the summer of 2020 with significant questions. First, would the OPEC+ reduction agreement hold and prevent another collapse of oil prices? Second, would COVID-19 behave like the seasonal flu and die out in warm weather, bringing increased economic activity and a drawdown in oil inventories?

By mid-July, the answers were apparent. The OPEC+ agreement did put a floor under oil prices, at a fairly low level. And the pandemic did not fall back as higher temperatures spread across the northern hemisphere.

In planning for the future, “one of the things companies should be thinking today is, ‘I cannot predict it.’ But the good news for the U.S. industry is that it’s a world-class, competitive industry,” Finley said.

When conditions improve, “these guys will be ready to go,” he predicted.

Finley said he isn’t too concerned about future investment and industry spending, because “human nature being what it is, when you have money in your pocket you want to spend it.” Investors will return to investing and the industry will ramp up spending when it has the means to do so.

However, “what’s going to happen is, coming out of this, every sector of the economy is going to be looking for credit and access to capital,” he observed.

Uncertainty is affecting both long-term planning and longer-term capital commitments. With today’s unknowns, “long lead-time projects are scary. We’re not going to see 10-year projects in the face of great uncertainty,” Finley noted

That could bring a short-cycle emphasis, but another factor to consider is that development timetables have shortened remarkably for the industry, he said.

“It may be harder to come by productivity gains now. I don’t see any data saying productivity is growing by 50 percent a year like it was the last time” the industry was in downturn, Finley said.

Some Predictions

In watching future developments that can affect the oil industry, he suggested several areas to keep an eye on:

Economic Reforms

“On the supply side, one of the uncertainties to watch is how much Saudi Arabia and other heavily oil-revenue dependent countries can reform their economies to be less dependent on oil production,” he said.

With reduced dependence on oil revenues, those big producers can be more comfortable in sustaining production cutbacks, he noted.

Behavior Shifts

The COVID pandemic had an immediate impact on social behavior and economic activity, but it’s uncertain how significantly long-term habits will change.

“Another question is, ‘How does it affect behavior going forward?’” he asked.

Finley said he heard a comment that it took air travel four years to recover from 9/11, “and this is way bigger than 9/11,” he explained.

“Is it temporary or long-lasting? No one can know right now,” he said.

Technology Development

In recent years, the oil industry has mostly focused its attention on internal technological advances. But technology developments outside the industry also bear watching, Finley said.

“On the technology front, I guess I would say, ‘Keep your eyes on batteries,’” he said, because improved battery technology could have a major impact on future transportation fuel demand.

Climate Change

“On the policy side, it’s climate change and the reality of having to do something about it, the pace and intensity of policies to address it,” Finley said.

Because of climate change reactions and regulations, operators may be “under a little more pressure to manage spending on the upside of the cycle,” he noted.

Anti-Globalization

Widespread anti-globalization sentiment could affect international oil companies going forward, combined with fragmented geopolitics, a return to tariffs and the willingness of the United States and some other countries to disrupt trade.

“My fear is that the pandemic can be an accelerant of that. And the U.S. industry is heavily internationalized,” Finley observed.

“One thing I’m watching with concern is that people say the IOC model is under threat, and they’re always focused on the ‘O.’ I’m more focused on the ‘I,’” he said.

Until events unfold and more answers become apparent, the industry outlook doesn’t just seem cloudy, but opaque.

“Over the longer term we have to be humble,” Finley said. “We have to start the framework from the perspective that we don’t know what’s going to happen.”

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