A new supply shock is oil’s $10 trillion question

A new oil supply shock could be just around the corner unless the industry starts investing fast. This was the stark warning delivered by the UAE's Energy Minister and current Opec president Suhail Al Mazrouei at the International Petroleum Week event in London on Monday. Despite the rise of US shale and the slow draining of global inventories, his prediction can’t be ignored.

According to Mr Al Mazrouei’s calculations, the world needs to invest $10 trillion – equivalent to China’s entire GDP – in order to replace natural field declines through to the end of 2040. What's more, this eye-watering figure will only be enough to maintain output at current levels. Even more capital investment will be required if global producers are expected to keep up with forecast increases in demand.

BP’s latest World Energy Outlook, released on the sidelines of the influential energy event, demonstrates the scale of the problem. Although the British oil giant is predicting around 300 million more electric vehicles on the world's roads over the next 20 years, it also foresees an increase in the consumption of crude oil. BP’s best case scenario sees the need for a further 13 million barrels per day of petroleum liquids just before 2040, bringing total world output to around 109 million bpd over the same period.

Mr Al Mazrouei asked the audience crammed into Park Lane’s Intercontinental: “From where will it come if we don’t start acting today?”

Given the current climate in the oil industry, his question is valid. Tepid oil prices of around $65 per barrel won’t guarantee investors the kind of stellar returns once on offer when crude hit its record level of $147 per barrel in 2007. Despite the efforts of all producers to become more efficient and profitable, at a third of those prices justifying renewed investment in production is a tough sell to shareholders.

Ironically, US shale oil adds to the problem. After hitting a new milestone of 10 million bpd in November, the US Energy Information Administration is now predicting that output will reach 11 million bpd by the end of this year. But the prolific nature of its growth makes investing elsewhere difficult to justify in the current climate.

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“We’re poised to become a net energy exporter within the next decade or perhaps even earlier,” said US Deputy Energy Secretary Dan Brouillette at IP Week. “This spells not just energy independence for America, it spells energy dominance, complete energy security.”

That’s a sobering message for Opec and its allies — especially Russia - to hear, following their unprecedented cooperation over the past year to rebalance overflowing stockpiles. Without their combined 1.8 million bpd of cuts, which have been extended until the end of this year, oil prices would be in free fall. However, the US threat of global energy dominance could encourage Opec and Russia to deepen their alliance further into a larger “super group” of producers, which would control around 45 per cent of global supply.

Of course, forecasts for peak oil demand vary widely. S&P Global Platts forecasts that global oil demand will exceed 100 million bpd for the first time this year, but doesn’t see an immediate threat of a peak. Opec's own predictions don’t foresee a crest until after 2040. BP, on the other hand, sees topmost demand arriving sometime in the late 2030s, primarily from changes in road transport and the need to limit carbon dioxide emissions.

Such uncertainty is a problem for investors. National governments in the Middle East, which control 60 per cent of the world’s proven reserves, can no longer afford to maintain investment in new oil capacity while diversifying their economies. Opening up more of their acreage to foreign investment from international oil companies is also problematic if they continue to restrict supply through their Opec agreements. Some analysts are also sceptical about fears of a supply shock, which could be caused by under-investment.

“There is no risk of a supply squeeze in the near term,” said Spencer Dale, BP’s group chief economist.

However, unless more money is spent replacing oil that has already been produced, then a supply shock could be unavoidable, despite even the most optimistic forecasts for US shale. Major fields in the richest areas of the Gulf such as Ghawar, Burgan and Zakum have been in production now for over 40 years. Although Iraq and Iran also claim the capacity to increase output, their intentions will be constrained without significant increases in foreign investment.

Outside the region new exploration areas such as the Arctic, which once held the promise of a bright frontier for crude production, now look off limits for most investors. If the world is to produce significantly more oil it will have to come from Opec, Russia and the US. Who pays for the $10tn bill is another matter.

Andy Critchlow is head of energy news, Emea at S&P Global Platts