Blackhawk Partners

Having been involved for over 10 years in both the “physical trading” and “investing” sides of the oil business, I am frequently asked about the major challenges facing oil traders and financiers in today’s volatile global oil markets and beyond.

Let me for the sake of simplicity summarize it all for you in here....

Like most predictions of a commodity production patterns, my personal analysis is of course subject to a significant margin of error, depending on the state of the world-wide economy, a drastic change in Chinese consumption patterns, or a sudden solution to major political tensions affecting a major oil producer (such as Iran), that could trigger a major decrease and even a collapse of the price of oil. By collapse, I mean a fall below $50 per barrel for one year.

I believe the oil market at large is today already adequately supplied with spare capacity of around 4 mbd. This should be able to absorb a major disruption even from a major oil producer like Iran. It is a fact that global production capacity is regularly surpassing demand, in spite of the political and infrastructural problems of several producing countries. Hence, the mere dynamics of supply, demand, and spare capacity cannot in my opinion explain the high level of oil prices today.

Some of you may assign serious risks within Saudi Arabia’s oil sector and a high possibility of political instability there. However, I believe the Saudi oil system is one of the most protected in the world, considering no major attack has ever been brought against it, and even the attempts to hit parts of it – such as in the 2006 raid against the biggest Saudi refinery – produced no result. Additionally, the Kingdom appears to be capable of coping with major accidents in a short period of time . In sum, a Saudi oil disruption would most likely be short-term (no longer than 6-12 months). It’s also worth pointing out that since the 1980s, several analysts have suggested the possibility of impending political crises and even radical upturn of the Saudi regime. However, these dire analyses fell short of reality: the Kingdom has proved to be solid and capable to absorb most challenges to its survival.

So although most people remain convinced that fundamentals are still in favor of a huge spike in oil prices given the increasing instability stretching from Russia to the Persian Gulf, my feeling is just the opposite.

The timing of a hypothetical downturn or collapse is crucial to understanding its duration and its impact on the global oil market. Most of the global projects in the works today are still being developed, with higher initial costs to adopt new technologies, build infrastructure, and overcome the learning curve. The downturn or collapse of the oil market would have a significant impact, particularly if it occurred before 2015, when most of these projects have yet to advance. However, the duration and effect of such a collapse would probably be of short duration.

A sudden dip below $50 would not necessarily suspend the development of many projects worldwide, but would only slow their execution. The exception would be those projects that hold the highest marginal costs, such as some Canadian tar sands projects, Venezuelan extra-heavy oils, Brazilian pre-salt formations, as well as those projects that can be stopped immediately, such as U.S. shale/tight oil ones those of OPEC producers, whose execution depends on the will of governments.

Such a response from oil companies and governments would soon curtail new production, leaving the world market vulnerable to sudden disruptions by geopolitical factors or major accidents once again. Furthermore, market instability would likely coincide with a rebound of oil demand, driven by lower prices. Market forces should then realign prices with the higher marginal production costs in less than two years.

Conversely, if an oil price collapse were to occur after 2015, a prolonged phase of overproduction could take place, because production capacity would have already accumulated and production costs would have decreased as expected. This is what happened to shale gas production in the United States between 2011 and 2012. In this case, market recovery will depend critically on the strength of the world economy as well as geopolitical factors affecting the steady flow of oil on the global market.

Finally, the worst scenario would involve a collapse of China, which would make any current forecast about the future of the oil market (and the world economy) useless. Being China is after all still today the current engine of the world economy and of oil price consumption growth, its collapse would leave the oil price fall without a floor.

The opposite may also be true, although it appears much less probable. A sudden, robust recovery of the world economy could hurt the equilibrium of oil demand and supply, particularly if accompanied by geopolitical tensions, pushing oil prices up once again. This scenario, however, would support an even stronger rush to develop new oil reserves and production.

I have no particular preference for any of these scenarios, or any combination of them, although I think that the probability of a significant fall of oil prices is higher than all other scenarios.
Once again, and contrary to what some people think, Oil is not in short supply. From a purely physical point of view, there are huge volumes of conventional and unconventional oils still to be developed, with no “peak-oil” in sight whatsoever. In fact, more than 80 percent of the additional production under development globally appears to be profitable with a price of oil higher than $70 per barrel. Other things being equal, any significant setback to additional production in Iraq, the U.S, and Canada would have a negative impact on the global oil market, given their potential for new production by the year 2020. Also, a significant setback of traditional big producers such as Saudi Arabia or Russia could have the same effect, proving once again that the oil market is global and none of its pieces (e.g., countries) can be insulated from the other.
For our geopolitical analysts assisting and advising U.S policy makers setting up energy policy, it is worth noting that through 2020 and beyond, more than 50 percent of the global oil supply will continue to come from a geographic arc stretching from Russia to the Persian Gulf. Every major event concerning this geographic arc will be critical to the overall stability of the global oil market.
Hence, a revolution in environmental and curb-emissions technologies is a must to sustain the development of most unconventional oils, along with a strong enforcement of already existing standards, rather than massive over-regulation. Without such a revolution – that will without a doubt have major geopolitical consequences - a continuous dispute between the industry and environmental groups will force government to delay the development of new projects and slow growth.
Hope this sets the record straight.

Please feel free to share your thoughts.

Thanks,

Ziad K Abdelnour

Ziad K. Abdelnour is President & CEO of Blackhawk Partners, Inc. , http://blackhawkpartners.com/ , Founder & President of the Financial Policy Council http://www.financialpolicycouncil.org/ and Author of Economic Warfare: Secrets of Wealth Creation in the Age of Welfare Politics http://www.amazon.com/Secrets-Economic-Warfare-Creating-Regulation/dp/1118150120/ref=sr_1_2?ie=UTF8&qid=1311437307&sr=8-2

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