I recently had the opportunity to spend several months with a number of college students. I was shocked to learn that many of them did not understand the principal of supply and demand.
The law of supply and demand is immutable: if the demand for a product is greater than the supply of that product, the price for that product will increase. If the supply of a product is greater than the demand for that product, the price of that product will decrease.
If there are no external mitigating factors or ‘black swan’ events, the interaction between supply and demand will follow a cyclical course. When the price of a product is low, consumption of that product will increase, driving demand upward. Eventually, demand will outpace supply, driving the price higher, which in turn will drive demand downward.
The Oil Price Cycle
Because oil is a global commodity, it is subject to the law of supply and demand. If we examine the historical price of oil and ignore short-term fluctuations, we see that the period of low oil prices (supply exceeds demand) ranges from seven to 15 years with an average length of 11 years. Likewise, the period of high oil prices (demand exceeds supply) ranges from seven to 13 years with an average length of 11 years.
Having observed that the supply-and-demand cycle for oil is close to 22 years, we can predict that low prices will stay relatively low from 2015 to 2026, give or take a few years. Based on past cycles, we can further predict that the price will fluctuate around $50.00 per barrel (in 2008 dollars).
And then came the black swans.
“Black swan events” are, by definition, unpredictable and rare. In 2019, the industry suffered two black swan events: a price war between Russia and Saudi Arabia and the COVID-19 pandemic. The first black swan increased supply and the second reduced demand. The response of the market was predictable: the oil price collapsed. That collapse was on top of an already low-price environment.
We now know that the impact of the two swans was “V”-shaped and the price has recovered to the pre-swan price. How long that interruption to the price-cycle will last is unanswerable. Pre-swan we could make a reasonable assumption that oil prices would recover in or around 2026. That might still be a reasonable date, or the date may move back a few years.
Predicting Demand
In attempting to predict when oil prices will move into a high-price cycle, and how high that price will be, we need to examine the expected supply-and-demand picture. Looking first at demand, we know, with near certainty, that demand will increase. There are several factors that come into play. First, the world is beginning to recover from the pandemic. As the world begins to move back to pre-pandemic life, demand for energy will increase. The second factor is that most counties in the world are seeking to increase their GDP. This will require access to affordable energy, including an increase in fossil fuel use.
Predicting Supply
There are three factors we need to consider when predicting supply.
The first of these is that many investors now demand that energy companies invest in green energy. In response to this investor demand, many companies have re-allocated resources away from oil and gas to renewable energy sources. This will have a near-term impact of reducing oil supply. Whether or not the investments on renewable energy can make up for the reduction of oil in the supply change remains to be seen.
The second of these factors is U.S. energy policy. The Biden administration has been hostile to oil and gas exploration, exploitation, refining and transportation. The administration’s actions have reduced the U.S. supply of oil. This is a double-edged sword: on one hand, the reduced supply will tend to drive prices upward. On the other, the increased prices will dampen demand, which will lower prices.
The third factor is – at least in my opinion – more deleterious to the industry in the long term: the loss of capability. Since the 1986 price collapse, the industry has steadily been losing the talent needed to find oil and gas. Those talents were usually taught by mentors and industry training programs that built on the geoscience foundations established in the universities. I would wager that almost every successful oil finder can attribute their success to their mentors. There are very few mentors left in the industry.
The lack of mentors means that those engaged in oil and gas exploration and exploitation will not be able to draw on past experience and lessons learned. This will impact the industry’s ability to increase supply in the medium to long term
The Perfect Storm
Looking forward at supply and demand, I believe we are heading for a perfect storm. The oil supply is in a low cycle, and likely to stay low for the long-term. Simultaneously, energy demand is increasing. Barring another disruption to the normal supply-demand cycle, the two curves will cross, and energy demand will be greater than energy supply. When the two curves cross, oil prices will increase. Based on previous cycles, that increase will be significant.
That increase will occur as many countries around the world are working to rebuild their COVID-crippled economies and grow their GDPs. Since many of those countries are also importing oil, a significant increase in oil prices will have a devastating impact on their economies.
Recommendations
As a geoscience community, we are responsible for delivering energy to the world. If we are to avoid a major global depression, we must consider some changes to what we are doing.
Governments around the world should develop policies that encourage oil and gas investments. Our industry is safer and cleaner than it has ever been, and we can make a significant safe and clean contribution to the energy mix.
Energy companies should look at the long term. It is not good business for them to ignore their investors’ demand for green energy investment. However, it is not a good long-term strategy to effectively eliminate their efforts to find and develop oil and gas in lieu of clean energy.
As an industry we need to increase training and mentoring. Companies must learn that finding oil and gas is not a young person’s game. They need to retain their experienced talent for mentoring and to increase training.
AAPG, along with the Society of Petroleum Engineers, can play a vital role in helping to train and mentor the young talent in the industry.