One of the world’s most prominent oil industry analysts is Ed Morse, managing director and global head of commodities for Citi Research. The author, frequent speaker, academic and government advisor wrote an OpEd in The Wall Street Journal back in March 2012 titled, “Move Over, OPEC—Here We Come.” At the time, he said the U.S. was the new and world-leading swing producer of oil. More than three years later, how much has the picture changed, and what lies ahead ?

A seasoned oil observer, Morse has held top economist positions at Lehman Brothers, Louis Capital Markets and Credit Suisse. He’s frequently a contributor to Foreign Affairs, the Financial Times, the New York Times, The Wall Street Journal and the Washington Post.

He is chairman of the New York Energy Forum, and serves on the academic advisory boards at Columbia University’s School of International and Public Affairs and the University of Texas. He’s a member of the Oxford Energy Policy Club, the Council on Foreign Relations, and was an editor of The Geopolitics of Energy.

He was ranked #23 among the “Top 100 Global Thinkers of 2012” by Foreign Policy. For his pioneering contributions to energy research, he was honored by the International Association for Energy Economics.

Morse is no stranger to government’s views, either, as he worked at the State Department and later advised the United Nations Compensation Commission on Iraq, as well as the departments of State, Energy and Defense, and the International Energy Agency. He is a former Princeton University professor and author of numerous books and articles on energy, economics and international affairs. He also was at one time the publisher of Petroleum Intelligence Weekly and other trade periodicals and worked at Hess Energy Trading Co.

We caught up with Morse after he had made a quick trip to Mexico and Washington, D.C., arriving home late at night only to get up early for an interview at a New York TV studio.

Ed Morse

Investor Ed, Citi famously mentioned $20 oil recently, which sure got a lot of attention. Are you sticking to that or can you elaborate?

Morse Sure. I’ll elaborate on it. Keep in mind that was not our base case, but we did say there was a good 30% probability of it. Here are the drivers. One is that prices need to get to a point where increasingly expensive storage capacity can be accessed. Since finding incremental storage capacity gets expensive, the prompt or spot price needs to fall to cover the costs of storage, and since nobody’s buying the back end, it’s the spot or prompt price that has to give. It’s a one-way problem.

A second factor is, even if there’s enough storage in the U.S., there’s not enough in the rest of the world, so that too would push down the spot price.

If you run out of places to store oil, you need to get to a price point lower than the operating cost of a goodly amount of shale production. That’s how prices could fall below $30 a barrel.

Combined, these factors would be plausible drivers in the fall-winter market, and with refinery demand falling and production still growing in non-OPEC and the U.S. in particular, prices would have to be much lower.

Another factor is that Saudi production is rising and Saudi Petroleum is putting more oil into the U.S., which widens the spread between the light and heavier crudes. Beyond that, Iraqi production is rising and Iran looks likely to return to markets by late winter as sanctions are removed.

Finally, our chief economist recently wrote about the world economy going into recession, led by China’s faltering growth (defined as less than 2% growth), and that would carry with it significantly lower demand.

Investor What is the Saudis’ motivation?

Morse The Saudis lost significant market share in the U.S. and China through 2014, reaching a close to 50% loss in China by the middle of 2014 and almost 50% in the U.S. by winter 2014-2015. They had to take price action to be more competitive. If they keep this up, and we think they are going to, that creates more sustained market weakness. They are pricing very aggressively to increase their volume of sales and place the burden of market adjustment on other producers, including the U.S. and Russia.

Investor Are we near the bottom?

Morse All other things being equal, we think the market should start balancing by the end of 2016. The bottom has not yet been reached.

Investor Why does it take so long?

Morse One problem is that the market is seeing more growth in OPEC production than in losses in non-OPEC production, especially from Iraq and, just around the corner, from Iran. Another problem is non-OPEC output is being enhanced by lower costs of production everywhere, but especially in countries like Russia where currencies have depreciated, lowering opex and capex requirements considerably. Still another is that countries are reducing the costs of E&P by lowering taxes, a process abetted by the opening of Mexico’s upstream and the re-opening of Iran.

We think this winter-spring could well be a more difficult period, given Iran’s likely production comeback. But it’s always hard to call a bottom. Recent weekly EIA data are bearish given stock builds, just as weekly drilling activity data from the U.S. are bearish. Financial flows are pulled out of the market and into the market from single data points that are days apart. It’s a very volatile market based on all these short-term signals.

Investor What about government actions?

Morse Governments around the world have been quick to respond to this downturn, whether in Russia, where they are thinking of increasing taxes, or in Colombia, where they’ve been debating how much to reduce taxes. This makes the recovery longer and sluggish, more difficult to “sweat out” non-OPEC production.

Investor Is OPEC weaker or stronger?

Morse OPEC’s, or Saudi Arabia’s, negative power is strong—they have been exceptionally capable of reducing prices to punish other producers. But its more constructive power is clearly weaker than it was. They’ve demonstrated an ability to lower prices for everybody … but they look unlikely to be able to keep prices elevated.

As your readers would expect, they never doubted for a minute that the U.S. shale revolution would be way more resilient than the Saudis or anyone else thought. It’s defied the imagination, because of the incredible way that entrepreneurial inventiveness has managed the cost side of the business. At higher prices U.S. production likely will roar back.

Second, the relatively permanent drop in the cost structure of shale, deepwater and even oil sands undermines Saudi or OPEC intent. It won’t take as significant a shift in price to stimulate U.S. production now as it would have a year ago. The long-term winner is likely to be market forces and U.S. producers’ ability to produce at a lower price.

OPEC is in a stew because nonconventional technologies are so good that they deprive OPEC of being able to sustain prices well above declining non-OPEC production costs, whether in shales, deepwater or the oil sands.

So I think this is backfiring on them, and teaching them a lesson too, that they cannot reassert anti-market forces to get what they want. What they’ve always wanted is to have a gap between their low cost of production and the price in the market place. They can reduce prices when they want, given their spare capacity. But OPEC does not have the power to increase prices and revenue sufficiently without also stimulating production in the U.S. and Canada.

Investor The flood of capital to the sector has been a big factor, right?

Morse U.S. producers can grow production in a negative cash flow environment and the Saudis and other OPEC countries vastly underestimated the ability or the strength of U.S. capital markets to continue to provide debt and equity capital to enable these producers to operate and expand production.

This current adjustment period is certainly weeding out companies and assets that attracted undisciplined capital from those with more financial discipline. Undisciplined capital spending has led to production growth significantly higher than what greater financial discipline would have brought.

In the U.S., more than 70% of the production comes from less than 30% of the wells drilled. And 30% of output comes from around 70% of wells drilled. A lot of those wells are not economic and would not have been drilled in a more disciplined environment. Once the weeding out takes place, the industry is likely to be a lot healthier financially.

Investor Do you foresee more M&A ahead?

Morse We see a significant amount of industry consolidation taking place, but it’s been impeded so far by the huge amount of equity and debt capital available, by loan covenants that impede acquisitions and consolidation, and by company valuations failing to fall low enough to where the forward curve says companies ought to be valued. Eventually company valuations should become more challenged, and that should lead to accelerated consolidations.

Investor How do geopolitics affect markets?

Morse There are by definition always clear cut winners and losers when oil prices change. OPEC by definition strives to have the first oil to be marketed to be the most expensive so as to drive up market prices well above their own costs. Up to now, OPEC has taken actions to reduce production such that the least expensive production is shut in and the most expensive is produced first. That works well so long as the relationship of costs to high prices prevails in their favor. That works only if they don’t get so greedy as to protect a price that is so high that it stimulates non-OPEC production.

But over this half decade, Brazilian production rose by 26%, Canadian production by 42%, and U.S. production by 88%. This oversupply overwhelmed the market and OPEC recognized that.

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