The Davos Special

Here is what the future looks like

An engaging session on how oil producers are adapting to the oil market crash and the advent of shale gas

IHC vice-chairman Daniel Yergin [Moderator]: We’ll talk about the oil price collapse, why it happened, what is the impact and what it means for countries, for companies and for the world economy. I’d like to start with Lithuania’s president, Dalia Grybauskaitė. In December, the country took the first shipment of gas to a new natural gas floating regassification facility called Independence. So, I’d like to ask madam president why you called it Independence and how you view gas security in Europe. 

Dalia Grybauskaitė, president, Lithuania: My country is one of the recent ones in Europe to introduce energy reforms as we were 100% dependent on Gazprom for supply. Lithuania is a small country with no natural resources. We built this terminal in just three and a half years and with this facility, we are not only meeting our own needs but can also cater to neighbouring Baltic states, if need be. This is just a small example of how today’s global energy markets are changing and supplier countries need to take note of these changes, as we are not going to see prices of gas or oil at more than $100 levels.

Yergin: Sitting next to you is a country [Russia] that exports gas and oil. Deputy prime minister Arkady Dvorkovich, would you like to comment on this observation and the impact of lower oil prices on Russia? 

Arkady Dvorkovich, deputy prime minister, Russia: From a global perspective, gas will remain one of the most important energy sources for the world economy and the demand for gas will only grow in the coming decades. The structure of this demand will change over time as regions such as Europe are not growing compared with Asia Pacific. 

If gas has to be supplied at reasonable prices on a sustained basis, we need transparent and clear market conditions. We are not just a supplier but also a partner. On the basis of our partnerships, we can achieve sustainable long-term stability in the gas market. We are as much dependent on our clients as they are dependent on us. As far as Gazprom is concerned, the market is quite big and we will shift our focus to Asia Pacific and other countries. But in every aspect, a long-term relationship is important and we hope that all countries and our partners understand that. 

As far as alternative energy is concerned, it comes with risks and higher prices. So, we need to find the right balance between price stability and the safety of our consumers. For Europe, alternative energy will be an expensive proposition that will be costlier than Russian gas. Lower oil prices have impacted our balance of payment and resulted in a huge exchange rate adjustment. But lower Ruble exchange rates also give Russia the opportunity to promote exports of not just commodities but other products as well. 

Grybauskaitė: About the partnership and reliability of supply, we will be happy to have a reliable supply for Europe in general but our experience shows that energy prices from Gazprom were unreliable. It was also used as a political tool. So, that explains why our energy terminal is named Independence.

Yergin: Last November, the Opec took the historic decision of not cutting production. I want to turn to Opec secretary general Abdalla Salem el-Badri, who can tell us where the decision came from, why it was made and what are its implications.

Abdalla Salem el-Badri, secretary general, Opec: Four years ago, everybody was clamouring for an increase in production. Today, it is the other way around — Opec is being grilled for not cutting production. The decision was a collective one; everybody agreed with it. Yes, there is an oversupply but Opec did not increase its production [of 30 million barrels a day] for the past 10 years. On the other hand, non-Opec countries increased production by about 7 million barrels a day. Now, this 7 million barrels a day is coming at a very high cost, they needed a price of $100 to sustain it.

The problem at that time was that the price was correcting very fast, the fundamentals did not warrant 40-50% declines in prices. If we had cut production in November, we would have to cut again in March or June because this non-Opec supply would have replaced us. They would have replaced us with a very high price. So, we decided to keep the status quo, to keep our production the same and see how the market would behave. By the way, this decision was not directed either at the US or Russia. It was purely an economic decision by our ministers and we supported it. 

Yergin: Let me now turn to Fatih Birol, the chief economist of the International Energy Agency.

Fatih Birol, chief economist, International Energy Agency: I believe 2014 was a unique year both from a supply and demand perspective. In terms of supply, non-Opec countries have seen an increase in supply of more than 2 million barrels per day — the highest in the past 30 years. Second, on the demand side, global growth has been slow. China grew at its slowest pace in the past 25 years and Europe is still sluggish, while Japan is in recession. Further, there is one new fuel that is competing with oil in the transportation sector and that is efficiency. We have seen significant efficiency improvements in cars, trucks and jets and this is not a one-off issue. Today, three out of four new cars sold globally are subject to high fuel efficiency standards. So, efficiency is becoming a structural issue that slows down oil demand and we have seen its initial impact in 2014. 

Having said that, a large part of the growth [in output] for non-Opec countries was driven by $100 prices; hence, the current levels will have an impact on the high cost of production. Therefore, in my view, the current downturn is temporary and towards the year-end, prices will start trending upwards. 

Yergin: What will be the impact on supply?

Birol: In 2015, we expect oil and gas upstream investments to decline by about $100 billion and a big chunk of that will happen in high-cost areas. Its impact will not be felt immediately but over 2016 and 2017. And if that coincides with stronger demand, it will have a stronger impact on markets and prices. 

Yergin: Let us now turn to people who are actually in the business of producing oil and gas and discuss the consequences. Khalid A Al-Falih, CEO of Saudi Aramco, a large oil producer, could tell us his perspective.

Khalid A Al-Falih, CEO, Saudi Aramco: What is more surprising is that people are surprised that we are going through a downturn in the oil markets. After all, oil is the ultimate commodity and commodities do go through cycles like this. The high-price environment fuelled growth and supply, which the other speakers have talked about. At the same time, efficiency and high oil prices impacted demand and this imbalance came to the fore in 2014. I think the third factor that has not been addressed today is that the market was propped up to a significant degree by geopolitical fear and it was fuelled by financial investors. Ultimately, the fundamental reality in 2014 burst the bubble of geopolitical fear that was propping up prices. And then you have the fourth factor — I don’t know how big it is — the strong dollar and the winding down of QE also contributed to the acceleration in the collapse of oil prices. I think the market will have to balance itself.  

At the same time, given that many investors and the oil industry are shaken to a large degree, people will be a lot more careful before committing large sums of money to the mega projects of the oil and gas industry. In the short term, that will stabilise the market. But in the long term, it’s a worry to me and to my colleagues in the business because we know that in our industry, we have to invest big-time to not only meet the rise in demand from developing populations but also to replace the natural decline that is happening every year. We lose 5-6% of production every year, unless we invest large amounts of capital. So, those investment flows have to somehow be maintained and we shouldn’t be scared away by the current downturn. 

At Saudi Aramco, we’re balancing the short term with the long term. Like everybody else, we’re using the downturn as an opportunity to sharpen our fiscal discipline but are equally committed to our long-term strategy. We are investing in downstream — including refining and petrochemicals — which is not only creating value for us but is a part of what I call building resilience in the company; making sure that our portfolio is not overly dependent on upstream.

We may slow down a few programmes just to make sure our financials remain robust but we are maintaining our maximum sustained capacity to enable us to step up production in case of unexpected disruptions, which has happened many times before. 

Yergin: How is Aramco faring with its gas exploration? 

Al-Falih: We’ve had great success in three regions within the Kingdom. We have put a lot of money in the north of Saudi Arabia — just south of the Jordanian border — where phosphate mining and industrial development is going to be fuelled by this unconventional gas. We have drilled tens of wells and the results are very encouraging. We will start commercial production in 2016. So, the story we are seeing in North America for unconventional energy sources is, in my opinion, transferable elsewhere and I think Saudi Arabia will be the next big area for unconventional gas. 

Yergin: That’s very noteworthy because one of the big questions has been, when does the unconventional revolution travel from North America? So, how is ENI adjusting its investment and strategic plans?

ENI chief executive Claudio Descalzi: We think the cycle is not a structural one. I think the disappointment in 2015 has been more from the consumers, than about growth. The other aspect is that depletion in shale oil is very high, around 50% in the first year. That means that you need to invest much more than what we invest. 

Secondly, when Opec said it won’t do anything, there was a rapid correction in prices to $43 per barrel and you saw in the market that all the long positions soon turned into short positions. That creates swing and instability because the financial markets are 15-20 times bigger than the physical market. On our existing assets, the breakeven price is very low at around $15-20/barrel and for new projects in Africa, it is $30-35/barrel. So, we are not going to stop any projects but we will work down our costs. Having said that, just like we need a federal or central bank as a stabiliser, we need a central bank for the oil industry as well. 

Yergin: Abdalla Salem el-Badri, how do you like this notion of being the central bank of world oil?

El-Badri: We’ve been in this situation before. We have to be very careful with this crisis. We should not lay off our people like last time, when we laid off a lot of very experienced people and ended up having a problem with our projects.

So, we should really benefit from past experiences. Prices will rebound and you don’t need a central bank. Opec is being told to reduce production because non-Opec companies want higher cost of oil to come to the market. This logic does not make any sense.

I don’t understand why everybody is now crying that this is a decision against the US, that this is a war between Saudi Arabia and shale oil in the US. This is not correct at all. So, I think this cycle will correct and prices will rebound. But, this time, we have to carefully handle the situation. 

Birol: It’s music to my ears to hear Opec say that we leave it to the market forces to decide and I completely agree with the secretary general. While market forces will take time to readjust, in cases of emergencies, which is not the case now, we need — whatever you call it — a central bank or spare capacity. Saudi Arabia has often played a distinguished role in such situations, though we are not in a crisis right now.  

Yergin: So, which country do you think is the biggest beneficiary of the drop in oil prices?

Birol: I would say the US. If countries can make use of lower prices and put the right policies in place — as the window of opportunity may not last long — then they can emerge as winners. The Modi government in India has made a very good move by deregulating diesel prices. Subsidies can now be phased out in the time when we have lower prices. Some of the consumer countries can make use of this breathing zone. And the loser I would say is Russia because 70% of its export revenues come from oil and gas and it will also feel the impact of sanctions over time. 

Yergin: Arkady Dvorkovich, do you want to comment on this? 

Dvorkovich: First, we are not losers. Do not call us losers. 

Birol: Temporary losers.

Dvorkovich: At this price level, you can win if you are getting more efficient and this is what will happen in Russia. We will be much more focused on efficiency and even more focused on doing things that are commercially viable. We will learn not to enter projects that have huge risks. More importantly, we have a very flexible policy towards our oil and gas industry in terms of taxation and that framework allows companies to keep production largely constant. Even if you have a shortfall, it will be minimal. The companies will continue to invest in modernising their refining facilities and we will have higher quality fuels for both the domestic and international markets.

Falih: Let me reflect on the issue as I listen to the panel talk about this period where the dominant theme is abundance of supply. This is good for the global economy, for consumers and for importing countries. But what I hope it would result in is decoupling to a certain degree the politics from the flow of investments.

Today, we see a heavy-handed involvement of governments and their energy policies of restricting the industry from doing what the industry does best, which is to invest, innovate, reach consumers and move products. The big consuming countries don’t have open access for oil producers to invest and reach their customers. Perhaps it was justified at some point in time but today, the distribution of energy is more even than ever and, I hope that political intervention will not deter such energy investments.

Last year, when oil was at $100-110, many of my peers were talking about cancelling, deferring and reexamining projects, as they couldn’t justify them economically even at that price. We were not able to deliver on our capital expenditures with certainty and our confidence was shaken.

So, we commissioned collaborative efforts amongst the oil and gas community, we worked on it all year — many companies contributed and we extended our hands to our partners in the oilfield services and engineering community. And a number of proposals came about: most of them were in the area of standardisation, not just of equipment and specifications, but also of contracts and working openly so that we can invest together with our partners and suppliers to be able to deliver on our projects. 

The industry will have to develop 50-60 million barrels of oil capacity over the next couple of decades and that will require trillions of dollars of investment. That will necessitate that every supplier on the planet extends its capacity and, more crucially, we need to hire the right talent and innovate in an environmentally responsible way. We need to respond to the call on the industry and the new regime that will emerge out of the CARP negotiations in the not-too-distant future.

Yergin: Claudio Descalzi, would you like to add a quick comment?

Descalzi: Just two quick comments. The first one is on European energy security and the other is about managing costs in the future. Europe has a very important opportunity now because we have very low energy costs, unlike the past eight years of high energy costs. The US reacted and they found a way to reduce the cost and we didn’t. We are doing nothing to develop our domestic reserves, so that is a very important point now. 

Second, we didn’t act as a European community — each state had a different agenda. Because we are still suffering thanks to an infrastructure layout that is fully disconnected, we cannot exploit the two big south hubs — Italy and Spain — because there is no connection with the north of Europe. Italy is not connected and Spain is connected through a very short pipeline. We have to create a real common network as a state and not as a group of states with different agendas. 

As for costs, we have a good opportunity to renegotiate a few contracts. We also have a good opportunity to go back to the basics when, in the ’80s or the ’90s, companies had a strong grip on their projects and did not rely only on contractors. We had all our projects on schedule and within our budgets. But since 2000, when we became too rich, we became less efficient. 

The other point is technology. With low prices, we were able to develop a lot of technology but with high prices, we were not able to use good technology to develop new reserves. The only country that did that and has been successful is the US. Now is the moment to think about it.

Dvorkovich: Well, there are win-win situations in the world and if you invest in the right way, then both parties can be winners. Let’s imagine two scenarios, one, where the price is $110 and another where it $60-$70. I am not fully convinced that $110 is the best price — if the world is not doing well enough, that will impact Russia as well since we are all interconnected. Maybe, we are all better off with prices at $60-70 and not $110. 

Yergin: Abdalla Salem el-Badri, you wanted to add something?

El-Badri: This price will certainly affect the oil industry. But it’s not really about a winner or loser. Producers will look at their budgets and try to reduce some of the cost. It’s good for us and for consumers. I hope that the government will not increase taxes. Low prices will increase demand for sure but if the government increases taxes, then users won’t get anything. 

Birol: We have to put things in context. We need to increase the global oil production in the next 20 years by more than 10 million barrels per day and the US alone cannot fill that gap. The US is still an oil importer and will be one for many years to come. Therefore, we should all understand that we will need west Asian oil. The fact is that west Asia is critical for the global markets and will be for many years to come. The other aspect is that losing countries need to be prepared for the next oil price crash. So, it is important that they diversify their economies beyond oil, so that they are no longer vulnerable to such price fluctuations. 

Yergin: I think we’ve got a very panoramic view of the market and have learnt a lot from our panelists. Thank you.