[Editor's note: A version of this story appears in the July 2018 edition of Oil and Gas Investor. Subscribe to the magazine here.]

In early May, as West Texas Intermediate (WTI) exceeded $70 a first time in more than three years, energy markets consultant Jamie Webster addressed Oil and Gas Investor’s Energy Capital Conference attendees. As senior director for the Boston Consulting Group’s Center for Energy Impact, Webster is no stranger to prognosticating oil markets. He’s a regular at the semiannual OPEC meeting in Vienna and has advised Congress in special hearings on various occasions.

He thinks $70 is a “fantastic number,” but was not surprised when it achieved that level, adding “there’s a lot of room for shale to grow this year.”

Industry must be diligent in promoting the good news that shale production brings to the U.S., he emphasized, including lower energy costs, lower emissions and high-quality jobs. But there is none greater than energy security.

“Every president since Nixon has talked about the need for greater energy independence. There’s no question that the increase in U.S. energy production both in gas and oil has increased energy security—not just in the U.S., but globally. This is a very good news story.”

VIDEO - Analyst On US Shale’s New Role

Webster visited with Investor on some of the macro issues shaping the energy world at this time.

Investor: What’s the role for U.S. shale in the global picture?

Webster: It’s a big producer and big exporter. And while it’s a relatively small part of the total global energy supply basket, it is still a major force. It has the real ability to be able to handle increases in production, so that, when prices go higher, it can bring prices down. It’s more responsive.

Shale’s key role is its ability to grow production in the short term. This is going to be extremely important as we have a looming hole in production over the next several years. This is going to give a lot of opportunities to, but also put a lot of pressure on, shale to produce quite a bit or we will risk—if you want to call it a risk—much, much higher prices.

Investor: How has the opportunity to export changed the outlook for the U.S. shale market?

Webster: That’s a big deal. The U.S. is becoming a major part of the global system. We are now exporting crude to about 25 countries, and we just started this at the end of 2016. About 7.5% of global exports come out of Texas. We also export product to about 136 countries.

What it means is that, for every other producer and refiner out there, you have to compete against the U.S. The U.S. is pushing these barrels in every place it can get to, so that’s creating more competition—for the Russians, for the Saudis—everywhere that someone wants to place barrels.

OPEC’s view has started to shift that shale is a pretty small player, so they don’t need to worry about it. This to me is extremely puzzling because, yes, it is a relatively small amount, but it’s also the most responsive in terms of prices. It can move very quickly.

Investor: What is the significance of the upcoming (June) OPEC meeting?

Webster: The No. 1 thing to look at is its relationship with Russia. Russia is the most important thing in understanding how this (production cut) deal is going to continue.

Russia is only responsible for about 300,000 bbl/d (barrels per day) of the roughly 1.8 MMbbl/d that is off. It doesn’t sound like a big amount, but it punches well above its weight because, if Russia changes its mind and decides to pull back, you’ll see the other non-OPEC countries doing the same. Then you will start to see the noncore OPEC members also taking their barrels and putting them back on the market—those that are able.

Investor: How does this OPEC deal end?

Webster: It will not end with an announcement. It will end with a slow accumulation of additional barrels—likely by Russia—and, then, the other dominoes will start to fall with the remaining members.

OPEC right now has been completely successful. Their plan was to try to bring (crude) stocks down to the five-year average, which they have done. And they’ve started to recognize that this isn’t a great metric if they want to keep the members incentivized to keep producing at a lower level. So they’re starting to look at other metrics.

There are tacit reasons why they want to keep prices a bit higher. And they’ve got a number of members that aren’t able to increase production. We’ve seen the falloff in Venezuela—not because they’re trying to comply with the OPEC agreement, but because the country is just in shambles.

Investor: What happens now that the Iran nuclear deal is not certified by the U.S.?

Webster: Recognize this is just the first salvo. If the Trump administration decides to pursue sanctions as were in effect during the Obama administration, you could see 600,000 to 1 million barrels a day of production coming offline out of Iran, which would have a huge boost on prices. That fact could cause the Trump administration to go after some other part of the Iranian economy.

Some would say that because Europe was not interested as it was in 2012, the U.S. doesn’t have that capability. You have to remember: We also have a lot more capabilities on sanctions than we did five or six years ago. Our ability to sanction outside of our country continues to rise and actually gives us a lot of power, even with countries and companies that don’t interact directly with the U.S.

Investor: What impact might the lack of FIDs (final investment decisions) on big projects globally during the past few years have on the price of oil?

Webster: The potential of getting above—$100 oil over the next year to year and a half is entirely within the realm of possibility. We have a looming hole in production growth from the non-shale, non-OPEC producers. They reduced investments quite a bit, which means over the next couple of years we don’t have as many barrels coming online—and those barrels that are coming online are largely gas barrels. Especially if we continue to have strong economic growth, you could end up not having enough production coming online to handle that additional growth.

In 2014, non-OPEC, non-shale production growth was 1.2 million barrels a day. This year it is expected to be 0.2 million barrels a day. When you’ve got just that little bit—and over the next couple of years it could be in the negative—that means that shale needs to grow that much faster.

You’ve got other things you can pull from: The OPEC deal could unwind and that 1.8 million barrels a day could come back into the market. But you have the real potential that you could hit higher prices in the next year and a half—just because of the supply and demand balance.

So that puts a lot of pressure on shale. It would not surprise me if we see $100 a barrel in the next year to year and a half, but I don’t think it will last that long because of the greater responsiveness of the system.

Investor: Considering the high decline rate of shale wells, is there a possibility that shale producers can’t keep up with demand?

Webster: That’s a real possibility. The decline rate is growing and continues to grow, and the faster you add production, the higher the decline rate gets. Now that we’ve drilled up Tier 1 acreage in a lot of plays, the ability to bring on a lot more production growth is actually a much bigger challenge. If this was two years ago, we would be showing two to three times actual growth because two to three years ago our decline rate was around 200,000 barrels per day per month. Now it’s around 400,000 barrels a day per month.

Investor: With WTI above $70, and Brent hovering near $80, what’s the biggest threat that could upset the apple cart?

Webster: In the near term, it’s OPEC changing its mind and not following through on its deal. The other part is the global economy. If the global economy doesn’t keep growing, then you don’t have room for shale to continue to grow, and you’ll see prices come down quite a bit. You still need pretty strong growth to be able to mop up that increase in production.

Investor: The industry seems to have a fear of producing too much too fast. Is there a risk of a pendulum swing to the downside if overproducing again?

Webster Yes, that’s entirely possible. The oil market is much more responsive than in the past. What that means is that shale can come on quickly; you can have a lot of production in the face of higher prices, which can then bring prices down really fast. You could start having more intense, shorter-cycle, boom-bust periods, which is difficult for producers and consumers to deal with.

Investor: Regarding natural gas, is “$3 forever” an optimistic viewpoint?

Webster: We could get to a point where $3 (per million Btu) is nice to have if you’re a producer. You’ve got a lot of downward pressure on natural gas prices over the next couple of years.

The Permian (Basin), as it grows, also has a bigger gas cut. You’re going to see a huge amount of gas coming out of there, not because producers want it, but because it’s being produced alongside oil. You see companies like Tellurian (Inc.) and others doing everything they can to export it, but exporting it into an increasingly crowded global market. So I think it would be nice if producers could continue to get $3. It wouldn’t surprise me if it goes lower.

Investor: Is there any hope from the demand standpoint for a price lift for natural gas?

Webster: You would need to be able to take on an awful lot to absorb that much. We’re exporting, but that’s limited. We are increasing it in terms of the power generation stack, but that’s limited because coal is still entrenched in a number of markets. You’re also seeing things like in California where they’re bundling renewable energy with batteries and effectively making natural gas the new coal. So there are fewer opportunities there.

Petrochemicals is a big place where you can see a lot of opportunity, but that is still a relatively limited opportunity set. Unfortunately, we had a period of time where natural gas might look like a great way to power vehicles, but there is not as much attention on that as there was in the past.

Investor: So what’s your message to the U.S. natural gas industry?

Webster: The big potential positive for natural gas is getting countries to recognize it as the first fuel source they should look at. A lot of countries, particularly in Southeast Asia, are going through a decision process right now on coal or natural gas. For landed prices there, natural gas is too expensive relative to coal. If you can help these countries with investments to get in natural gas, then that creates a market for you.

So the focus on developing these markets, particularly in the developing world, where they benefit not only from reliable power, but also lower-emission power that you get with natural gas, would be a real boon not just for U.S. producers, but also for those communities there as well.

Investor: What will the oil and gas industry be talking about next year?

Webster: Given the potential that prices could go higher or at least stay near these levels, the discussion is likely to shift to balancing the need to provide share buybacks and a strong dividend against the need to bring on new projects and more energy, particularly oil—all while still recognizing the broader energy transition that is happening and many companies are embracing in various ways.

Steve Toon can be reached at stoon@hartenergy.com.

Comments