This article was originally published on the website of CFA Institute
At the 2015 CFA Institute Middle East Investment Conference, energy expert Fereidun Fesharaki presented a grim picture of the global energy markets. Against a backdrop of volatile energy prices, the founder and chairman of FGE discussed the changing energy landscape and argued that the recent major drop in the oil price is structural rather than cyclical, adding that he expects a rebound in the oil price only in 2017/18. He believes this structural shift is good news for the global economy but bad news for oil exporting countries.
The Structural vs. Cyclical Debate
Fesharaki’s main argument was that oil price change is structural because of the way the United States has transformed as an energy producer during recent years with very few people noticing. He explained that while the United States was producing between 4.5 and 5 million barrels per day (mbd) 2 to 3 years ago, today it is producing an additional 4.5 mbd, which is more than Kuwait at 3 mbd. In the liquefied natural gas (LNG) space, he said the United States is now among the top three exporters, while just three years ago it was importing LNG. And the same goes for propane, an important fuel in the energy system, he added. Qatar, Abu Dhabi, and Kuwait were the top three producers of propane about three years ago. Currently, US production of propane is larger than the three countries combined. Fesharaki argued that with the increasing US dominance in the energy sector, it is clear why the price adjustment is structural rather than cyclical.
Estimating the Likely Oil Price
Assuming no new dramatic geopolitical events, Fesharaki stated that he expects a price rebound in 2017/18 and that it will not be anywhere close to $100 per barrel but may be more like $70. For 2015, he expects the price of oil to be $5 more than it is now. He believes the oil price will be volatile with a $20–$30 swing in prices.
Fesharaki said that a steady and stable $100 per barrel during the last few years has made people assume that this is the norm, which has led to extraordinary investments in energy. Meanwhile, he continued, while supply steadily increased, thanks to the United States, Iraq, and Canada, demand continues to be muted. He added that Asia’s demand is 50% lower today than three years ago, as some of the Asian countries (such as India and Indonesia) made the most of low oil prices and removed subsidies that enabled a straight pass through, which created a demand rebound. Fesharaki said that the Middle East used to experience one of the highest demand growths, thanks to a young population, low prices (subsidies), and lots of cash. Now he believes that things have changed for the worse in the region and that most of the GCC countries are on track to pull back subsidies (except Saudi Arabia).
The Saudi Strategy
The announcement that Saudi Arabia will not lower production has ignited the current oil price collapse, Fesharaki said. He thinks this is not a political decision but an economic one that has political consequences. Saudi Arabia knows the importance of being a credible political powerhouse rather than an oil powerhouse, he added. Fesharaki believes that Iran provided them with an important lesson: After sanctions, Iran lost about 60% of oil exports and became politically irrelevant. So, he contended, defending market share is more important than defending price in order to be politically relevant. Before changing course, he said, the Saudis will now await new evidence, which may come by the end of 2015 or early 2016.
Fesharaki argued that at $40 per barrel (which is $15 lower than the current level), nearly 70% of oil producers in the United States will stop production. He believes we might see this price point somewhere in the second quarter, due to contraction in demand by about 2 mbd. At this price point, he concluded, investors of expensive oil (read shale oil) will reconsider.