Caspian Energy CE:Mr. Medlock, the global market has been in recession, what do you think the major reasons are? Which components – geopolitical or market mechanisms will influence the oil prices in the short-term and long-term perspective?
Kenneth B. Medlock III, Senior Director, Center for Energy Studies, Rice University: Global market weakness is due to a confluence of factors. Softening in Asia is primarily driven by slowing growth in China, but the prospects for growth in India and the ASEAN region are good. Collectively, the South Asia-Pacific region is home to over 2 billion people, and improving economic outlook for the region will be accompanied by greater demand for oil and natural gas. The economies of Europe will not likely improve dramatically in the next decade, which means energy demands will not be driven by developments in Europe. More generally, the developed economies of the OECD are not likely to drive demand much in the near term, with the one exception potentially being the US. In the US, demand for petroleum products is growing with lower oil prices and an improving domestic economy.
The price of oil is sensitive to both geopolitical and market mechanisms. The biggest weight on oil prices currently is the very robust global inventory situation, which signals an very well supplied market. Growth in demand and a slow-down in oil production will help rebalance the market, but this is unlikely to occur until well into 2016. Complicating factors are the reentry of Iran, the resilience to date of US shale oil production, the effect of sanctions on Russia, the conflict in Syria and the potential for it to spread, and issues affecting Latin America (Venezuela and Brazil in particular). As each of the factors plays out, we could see markets tighten in the next decade just easily as they could remain relatively well-supplied. In sum, there is tremendous uncertainty with regard to the direction markets will take in the next ten years.
CE: What role is assigned to American shale oil in current crisis developments?
Kenneth B. Medlock III: Rapid growth in relatively low cost shale oil has been a major contributor to the drop in oil prices. In fact, over the period from 2008-2014, global oil production increased in multiple countries by a total of just over 11.5 million barrels per day, with the US accounting for about 5 million barrels per day of the increase. This was partially offset by declines in countries experiencing sector mismanagement (Mexico and Venezuela), natural decline in aging fields (UK and Norway) and civil strife or sanctions (Syria, Iran, Egypt, Libya, and Algeria). The net increase in global oil production from 2008-2014 was just under 6 million barrels per day, which matches the growth seen in the US and Canada combined. So, US shale played a pivotal role in keeping global markets relatively balanced since 2008. Since mid-2014, however, faltering demand in Asia coupled with a reluctance by OPEC to cut production has contributed to an over-supplied market. The resilience of shale oil output in the US in the face of low prices has also contributed. In fact, it has been viewed as rather remarkable to many analysts as productivity gains encouraged by lower profit margins have contributed to maintaining US oil production. This is likely to fade, however, as price remains near $40/b. That raises an important point. Namely, the future of US oil production is highly sensitive to price.
CE: Do you have any predictions regarding the situation at the market? Does not it seem to you that today everybody is waiting for the time when the American producers will finally yield their positions, though they don’t even think about it?
Kenneth B. Medlock III: U.S. shale oil producers are beginning to react to lower oil prices as can be seen by the decline in well completions and the idling of drilling rigs. The reaction by US producers has been slow to materialize for multiple reasons, but these reasons are beginning to fade meaning US oil production will begin to decline, albeit slowly, over the next several months. Importantly, multi-national oil companies are also cutting back offshore conventional exploration and development budgets around the world, which foretells of slower growth in production from multiple domains. As demand grows, even if modest, price will increase as the market rebalances and potentially even tightens.
CE: In your opinion, which measures shall OPEC undertake in order to recover the market share?
Kenneth B. Medlock III: It is doing exactly what it should do if recovering market share is the goal. High oil prices were allowing more expensive non-OPEC oil to capture demand, effectively replacing low-cost crude oil options such as that produced in Saudi Arabia. Therefore, Saudi Arabia's unwillingness to cut production is aimed at recovering market share. Longer term, global economic growth will require increased oil production and several Middle East OPEC nations (such as Iraq and Iran in addition to Saudi Arabia) have low-cost resources that, with the right investment decisions, have the opportunity to maintain a significant share of the growing global demand for oil. Of course, such an outcome hinges on regional stability. The threat of instability remains, and when one surveys the landscape of future oil production against a backdrop of growing global demand, new production in the Western Hemisphere – ranging from Canada, Mexico and the US to Venezuela, Brazil and Argentina – will be critical to the balance of global markets.
CE: How do you assess Saudi Arabia’s chances in the fight for the share of the global market?
Kenneth B. Medlock III: Saudi Arabia has significant low-cost resources and, thus, has a competitive advantage in the long term. This bodes well for its desire to maintain an important and dominant market position. However, it will be incapable of capturing large segments of new demand growth, meaning its market share will likely erode. However, it will remain an incredibly important global supplier with one of the most vital roles in providing long term market stability.
CE: What role will Iran play in the global energy market in coming years?
Kenneth B. Medlock III: Investment will flow to Iran, from European firms and Asian firms, but US firm involvement still remains clouded due to unilateral sanctions and US political pressures that will not fade in the wake of the nuclear deal. More generally, with regard to the European and Asian firms, what will be the contract terms offered by Iran to foreign oil companies, and how will this impact investment flows into Iran? Iran has large oil and gas resources and is an incredibly attractive place for firms to add reserves to their portfolios, but it is not a forgone conclusion investment will happen in large amounts. In particular, the right policies and incentives need to be in place for Iranian output to grow to its full potential and ultimately see its exports of oil (and natural gas) grow significantly.
CE: Do you think there is an energy component in the current situation in Syria since the Arabian gas pipeline from Qatar should have crossed through this country?
Kenneth B. Medlock III: No. That pipeline proposal is challenged for reasons unrelated to the conflict in Syria. The conflict is clouding matters, but commercially the project faces strong headwinds.
CE: When do you think LNG supply from the USA to Europe shall start? How will the USA benefit from it? Which obstacles can arise in this regard?
Kenneth B. Medlock III: The long-term market for US LNG is not Europe; it is Asia. Russia, Norway and the Middle East have lower costs in serving Europe than does the US. Moreover, European demand is weak and not growing, so there is no growth margin to capture. Nevertheless, US LNG might flow to Europe on occasion due to spikes in demand or problems with supply from other nations. Much of the “promise of US LNG” into Europe was built on concerns related to dependence on Russian gas, particularly in Eastern Europe. However, Middle East supplies are very well situated to abate those concerns and provide much needed fuel diversity. US LNG will likely only play a short term balancing role in Europe, with baseload supplies coming from traditional regions
CE: Can the gas market become finally free from the dictate of oil prices and who will mainly benefit from it?
Kenneth B. Medlock III: Growth in international trade of natural gas as LNG and via pipelines, increasing flexibility in long-term contracts, and growing spot market trade will lead to more transparency of pricing, and eventually to a market where gas is priced based on gas to gas competition. This has been happening gradually over the past decade as new participants (both suppliers and demanders) have entered the market. The resultant growth in liquidity due to a larger number of players has already contributed to a greater proportion of natural as being traded on a spot and short term basis. These developments are of benefit to both producers and consumers of natural gas by introducing more market flexibility, which enhances energy security more generally.
CE: Early in October the House of Representatives of the US Congress voted for the cancellation of the moratorium on American oil export, which lasted for 40 years. In your opinion, what will the US economy gain from adoption of this law by the senate and its further approval by President Barack Obama?
Kenneth B. Medlock III: Yes. In general, barriers to trade reduce market flexibility and limit the most high-value uses of the affected commodity. Yet, we sometimes can justify trade restrictions for other reasons. However, in the case of oil, the current ban is bearing a net cost. The oil export ban has forced light tight oil produced in the US to sell at a discount to similar quality crudes that are openly traded in global markets. This occurs because domestic oil can only be marketed domestically, so it is forced to be discounted to incentivize US refiners configured to run heavier crudes to use the lighter oil instead. That discount discourages US crude oil production at the margin. However, because the export of refined products are allowed, US consumers are faced with refined product prices that are in parity with global refined product prices, meaning they are not seeing a benefit from the oil export ban at the pump. A relatively small segment of refiners (but not all) are benefitting, but the benefits do not outweigh the costs. Thus, removal of the export ban, should increase US tight oil production, all else equal, without impacting US gasoline prices. US refiners of light tight oil will see their margins negatively impact by the removal of the crude oil export ban. On net, the U.S. economy would likely see a positive impact from the removal of the crude oil export ban, although it is not likely to be significant.
CE: What are the prospects of the Trans-Caspian gas pipeline? Do you think that the Trans-Caspian gas pipeline could become a part of several large-scale projects, including AGRI and TANAP?
Kenneth B. Medlock III: I think the prospect is limited. The Caspian is defined as a “lake” in terms of bodies of water, so the rules for transboundary infrastructure development or not conducive for the pipeline. Ultimately, all countries that border the Caspian must sign off, and I think this is unlikely. If it were built, then it would be an anchor project for the other systems you mention.
CE: Do you think that the Trans-Pacific Partnership (TPP) with the Pacific region countries and Trans-Atlantic Trade and Investment Partnership with the EU will strengthen competitiveness of export of American energy resources to these markets?
Kenneth B. Medlock III: Yes. Removal of trade barriers should open more markets for US oil and natural gas, assuming of course that the US removes barriers to oil exports. The impediments to LNG exports would be reduced significantly however, as many additional potential customers would be reclassified and trade with them would be deemed in the national interest.
Thank you for the interview