Thoughts on booms, busts, cycles, “MPG,” China, India, and the Next Big Thing.
“If you can explain oil, you can explain the world.” So began Garrett Golding, vice president of the Rapidan Group, in his luncheon keynote address before the membership of the Permian Basin Petroleum Association on Feb. 22. Speaking in the banquet hall of the Petroleum Club in downtown Midland, he proceeded to “explain the world,” as he moved quickly through several global and local scenarios in sizing up current conditions and offering a prognosis for the short and longer term.
Golding, who heads Rapidan’s Dallas office (the firm’s national headquarters are in Washington, D.C.), said that his company looks at the “MPG’s” of energy: Markets, Policy, and Geopolitics.
“To begin, we view the oil market as being in another historic boom-bust phase,” Golding said. “[From] the dawn of the oil age in 1859 up until the late 19th century, the oil market was dominated by booms and busts because we would discover a new field and we would deplete it rather quickly—because no one knew what they were doing, and there wasn’t a main source of consumption at the time before we really had vehicles taking it up. It was still just a substitute for whale oil and illumination. The market was completely haywire at this period. Once it started to be more commonly used, you had Rockefeller come in and he said this is no way for a modern industry to function. So he controlled the midstream and downstream and put in place an extremely low volatility environment by managing the market and, more importantly, managing spare production capacity.”
Something Wars are Won With
Golding noted that, with the Progressive Era that came in during the early 1900s, with the trust-busting that went on then and the anti-trust laws, Standard Oil was lost (it was broken up) and what ensued was another boom-bust cycle. These fluctuations predominated in the early 20th century until the Allied powers came together after World War I, and declared that oil is now a “strategic commodity”—that it is something wars are won with.
Golding: “And so we handed over control of the oil market to the Texas Railroad Commission and to the Seven Sisters. And for several decades they were the preeminent and most successful delegators of spare production capacity. We think of Texas as a free market, pro market state with a very successful oil industry, but we have examples in the 1930s of the Texas National Guard coming in and shutting down wells in East Texas. That’s almost Stalin-istic in its nature but it’s something that happened in this country, in this state. And ever since then—ever since the 1970s, specifically March 1972, when the Texas Railroad Commission handed over authority to OPEC and the Saudis controlling the market—well, we date it to March 1972 because that’s the first time that the Railroad Commission ordered full 100 percent production across the state and had no more spare production capacity.”
At that point, then, the Saudis controlled spare production capacity. But as Golding showed from his charts, the Saudis did not have a very successful track record of managing the market.
“We [Rapidan] put all this into a volatility study each year of how much prices can swing over the course of 12 months,” Golding said. “You can see today how what we call ‘Boom-Bust Three’ is only matched [for volatility] by the dawn of the oil age, which is pretty remarkable.”
That brings things to more modern times. As Golding indicated, OPEC has lost control of the market and a lot of people, as well as a lot of press, pointed at the November meeting as, “OPEC is back. OPEC is asserting its authority again.”
OPEC and Compliance
“But we see a problem with that for two reasons,” Golding said. “One, the cuts that they announced aren’t enough to balance out the market and draw us into a deficit for the end of this year or going into next. Second is compliance. And what we see here [referencing one of his charts] is some of the figures came out of the last few weeks, indicating that OPEC is ’90 percent compliant’ with its cut. Well, if you look into the figures it’s really the top line number is being complied with, but it’s because the Saudis have over-complied. And you have a lot of other countries that aren’t [complying]. And this could cause the agreement to fray sometime in March, May, or maybe June, before the next meeting. You also have countries that are not included in the agreement like Libya and Nigeria that are increasing production as they come out of Civil War over the next few months. Or not come out of it—but still have some improvement to their production.”
Golding remarked that another factor that could impact volatility—that in fact will happen—is something that involves many of the people listening to him there in the Petroleum Club on that Wednesday. And by that he was referring to U.S. oil production—and how it is going to swell.
There has been an obvious uptick in activity in the last six months, he noted. And beyond that, more money is being put to work in the oil field and, as he noted, Rapidan sees this investment as having “a pretty significant effect” on the market by the end of this year.
“We have a 600,000-barrel-a-day increase in our modeling from December of last year to December of this year just in the Permian,” he said. “This is part of the EIA’s [Energy Information Agency’s] modeling right now. Particularly going into 2018. But as we’ve seen over the last several years, EIA doesn’t really look beyond 12 months, so our forecast, even though it has a massive delta with EIA in 2018, is actually somewhat in line with most private sector forecasts right now.”
A Glut in the Making?
The question, then, could be asked: what has any of this to do with price? Golding said that Rapidan sees a swelling balance through the end of this year, which causes the firm to believe that there is not only a market that is likely to be glutted, but also that “we have a very long market in financial markets right now, where you have institutional investors, pension funds, others that have decided to get back into commodities and they’ve bought oil. The net speculative length in crude in both NYMEX and in ICE right now is at a level we haven’t seen in three years. If there is some kind of a thunderclap, like U.S. production increasing 100,000 barrels each month sometime this summer, [and] if there is another OPEC meeting disintegrating in disarray, well, this could cause a big liquidation in that position and cause us to drag down a little bit further sometime this year.”
But for all of that, looking out over the medium term, Rapidan feels the market will get to the end of the decade “in the same place” no matter what happens this year, Golding said. He said that if we do have fairly steady growth between now and 2020-21, we’ll still have deficits because the globe is going to consume more oil than people realize that it will.
And that leads to what Rapidan sees as another big surprise for the market. About once every five years something shocks everyone with something that few people could have seen coming but that has a pretty massive effect, Golding said. In the mid 2000s it was how much oil China and India would consume and that’s what led to the big run-up in 2006-2008. The early part of this decade it was how much shale would come into play. While that might not have been a surprise in West Texas and New Mexico, it was, nonetheless, a surprise to a lot of analysts in New York and D.C.
The Next Big Thing
“What we see as kind of the Next Big Thing is how much oil the globe is going to demand over the medium term,” Golding said. “And we say that because a lot of the analysis on the emerging world, on China and on India, takes the efficiency gains that we’ve seen in the developed world and places those on the developing world. Each time we have a new forecast or oil demand out of China and India and other developing nations, it gets increased by IMF or by IEA or some of these other consensus-forming organizations. And what that leads us to think is a lot of those balances from those consensus organizations miss the mark by over a million barrels each year over this medium term.
“So on the policy front on our MPGs, I like to call this the air war and the ground war. The air war being in Washington. The ground war is the state and local environment. Why do I call it the air war? It’s because in warfare one usually finds one opponent who is a technologically superior opponent. And that’s what we have in the energy industry and their ability to shape policy in Washington. When you have a technologically inferior opponent they resort to guerrilla tactics, and that’s what we’ve seen with environmental groups in the state and local environment. So why this is important is because I see the Washington risk as somewhat muted. Not just because we have a Republican president and a Republican Congress right now. But we really saw an Obama administration that came in in 2009 and wanted to practically declare war on frac’ing. They already had a war on coal—really, on fossil fuels. And they had an ear to the greens and a very empathetic ear to green groups who were wanting to shut down frac’ing.”
But Golding believes that one good thing—and maybe the only good thing—in 2009 in the economy was the shale sector. Politically, that meant that the Left had a little more openness to not cracking down on the sector quite as hard as they wanted to, and led to allowing LNG and crude exports, which (as Golding suggested) no one thought possible just a few years ago.
Golding had much more to say, including thoughts on tax reform, the Border Adjustment tax, global hotspots, and Fuel Economy Standards—more than we have space to report on here—but it seems that the most optimistic point he holds out for the industry is the bullishness of (eventual) global demand for oil (perhaps higher than most are expecting). And if there is a need or challenge that most confronts the industry, it is the need to compete in the “ground war” for people’s support and public good will. That’s fought more at the state and regional level than in Washington, and it is there that oil and gas is not so focused.
Just prior to Golding’s talk, PBPA President Ben Shepperd shared some remarks about the Association’s recent work, and the issues being faced.
“We have three offices [Midland, Austin, and Santa Fe] and thankfully we’re using all three of them nowadays,” Shepperd said. “We’re very busy in both the capitols of New Mexico and Texas, given that there are two legislative sessions going on simultaneously. So you all know the facts and figures of the Permian Basin it continues to grow in importance, and frankly there’s a lot people who now know about the Permian Basin who’ve never heard of us before or gave us much thought in previous years.”
He remarked that PBPA is still trying to understand what the impacts are, of the newly elected President and his Administration, on us as individuals and us as energy professionals.
“There’s been a number of new faces,” Shepperd said. “There’ve been new cabinet members approved: Rex Tillerson, longtime CEO of Exxon Mobile, as Secretary of State. Of course Scott Pruitt, Oklahoma Attorney General, was recently approved to lead the Environmental Protection Agency. And Rick Perry has been nominated [more recently was approved] to run Energy. Ryan Zinke of Montana, a freshman member of Congress, has been nominated to run the Department of the Interior. These are, among others, some of the key ones we’re watching and looking to develop relationships with. We clearly have developed a rapport with staff at the Department of Energy, Interior, and other agencies and will continue to do so.”
Shepperd said there is a long list of agencies and impacts that are going to change the way we do business at least for the foreseeable future.
“The last eight years have been extremely difficult,” he said. “The previous administration was very, very busy, adding costs and complications to our industry.”