www.wpcserbia.rs |  Bulten 26, January 2018

INTERVIEW: Mehmet Ogutcu, chairman of Global Resources Partnership and Bosphorus Energy Club

Oil markets’ new dynamics and unknowns: What to expect and how to prepare in 2018?

“Oil prices rallied in the first week of 2018, supported by increased geopolitical risk and severely cold weather in the eastern US, but the ‘perfect storm’ that pushed oil prices higher also raises the risk of a correction and of heightened herd mentality in trade. Protests in Iran, possible new US sanctions against Tehran, Saudi domestic dynamics, and Venezuela’s economic collapse could be the main geopolitical risks that could drive oil prices up this year. In this age of disruption, there are too many unknowns to predict what will happen next week, let alone 52 of them into the future. So instead of predicting where the oil markets will be by the end of 2018, we should outline some of the key unknowns in energy markets for this year: oil production, prices volatility, return of the geopolitics, China effect…,” said Mehmet Öğütçü, chairman of Global Resources Partnership and Bosphorus Energy Club.

By Vladimir Spasic

NNKS-WPC BULLETIN: Overall world production in 2018?

MEHMET OGUTCU: World oil production is going up. The oil industry has changed in fundamental ways. First, OPEC reduced output to put a floor under prices. On November 30, 2016, its members agreed to cut production by 1.2 mbd by January 2017. Prices began rising right after the OPEC announcement.

OPEC’s cuts lowered production to 32.5 mbd. The EIA estimates OPEC would produce 32.8 mbd in 2018. But both figures are still higher than its 2015 average of 32.32 million b/d. Throughout its history, OPEC controlled production to maintain a $70 price target. In 2014, it abandoned this policy. Saudi Arabia, OPEC’s biggest contributor, lowered its price to its largest customers in October 2014. It did not
want to lose market share to its arch rival, Iran.

Outside of OPEC, Russia has the greatest productive clout. Their cloaked restraint, or lack thereof, in a $60 world will determine whether oil goes to $75 or $45, with Putin keeping us guessing.

World oil consumption will be breaching 100 mbd in 2018, at a time when the Middle East’s cold war is ratcheting up. The uncertainty of whether an outage will occur is only exceeded by the uncertainty of what will happen in the event of a supply disruption

Inventories have dramatically declined, and are sitting roughly 100 mbd above the five-year average. The disruption in Libya, as long as the size of the volume knocked offline stays at the 100,000 bd level, probably won’t have a major effect on the oil market. Indeed, prices fell back after it became clear that the disruption was as small as it is.

But the market jitters are magnified by the fact that the oil market is a lot tighter than it used to be. An outage in Libya could help accelerate the rebalancing process, depending on how long it takes for the pipeline to see repairs. It also comes on the heels of a roughly 400,000-450,000 bpd outage in the North Sea because of the crack in the Forties pipeline.

NNKS-WPC BULLETIN: What about the US production?

MEHMET OGUTCU: It is actually benefiting from the OPEC deal by pumping more oil to the market. The US emergence as a dominant force in oil and gas production is changing the dynamic of its role in the global energy market. US oil production this year is expected to break through the 1970 record of 9.637 million barrels a day (this was below 5 mbd just before the shale oil boom) in the near future, securing the US industry’s role at the top of the energy world.The US is likely to continue to pressure global prices with more output, as Russia and Saudi Arabia work to prop up prices. Oil producers say that they expect the cost of drilling and producing oil will also rise this year. A growing number of companies also think that the efficiency gains are at least 25 to 50 percent structural, rather than cyclical. And finally, they expect to spend within their cash flow this year.

NNKS-WPC BULLETIN: Price volatility is inevitable?

MEHMET OGUTCU: In December, 2017, oil prices hit a 30-month high. Some pundits are suggesting that oil is now overvalued, and a pullback is inevitable. But a few lonely voices have been forecasting $80 oil by year-end. Indeed, if the crisis in Iran threatens the region’s oil production, $100 isn’t out of the question this year. There are a lot of headwinds for oil at this point. In particular, many oil producers are hedging at current prices, and there is a large backlog of drilled but uncompleted wells. The latter can bring new oil production online quickly as oil prices rise.

Concerns that electric vehicles are going to start taking market share from oil are way too premature. Oil prices will trade in a relatively narrow range this year, but ultimately the price of West Texas Intermediate could reach $70 from the current price is $61.59/bbl. Rising oil prices would benefit shale companies that have relatively less hedging, exposing them to a more positive market.

NNKS-WPC BULLETIN: What about your predictions for the longer time horizon?

MEHMET OGUTCU: We often fail in speculating for long term price levels but let me make an attempt. By 2025, the average price of a barrel of Brent crude oil could rise to $86and $95 by 2030. By 2040, prices could be $109 and $117 by 2050 (again in 2016 ollars). By then, the cheap sources of oil will have been exhausted, making it more expensive to extract oil. These forecasts all depend on 1) what happens with US shale oil production, 2) how OPEC responds, and 3) how fast the global economy grows.

If enough shale oil producers go out of business, and Iran doesn’t produce what it says it could, prices could return to their historical levels of $70 – $100 a barrel. OPEC is counting on it. High oil prices can result in “demand destruction.” If high prices last long enough, people change their buying habits. Demand destruction occurred after the 1979 oil shock. Oil prices steadily deteriorated for about six years. They finally collapsed when demand declined and supply caught up. Oil speculators could spike the price higher if they panic about future supply shortages.

NNKS-WPC BULLETIN: Would there be enough capital?

MEHMET OGUTCU: Capital is not the issue – there are so much money flowing in the market. It is to find the right projects with long-term stability and good rates of return with minimum risk.Bringing on energy projects needs a lot of investment. The shakeup of capital markets is inflicting opaque, collateral disruption to the energy business too.

Financial technologies are altering fund flows, market liquidity and access to capital. We thought self-driving cars were the only thing that could affect the oil business. How about robo-trading in debt and equity markets? Energy executives now need to be ‘fintech’ experts too. Crypto-currencies like Bitcoin have seemingly little to do with energy, but the underlying blockchain technology will be transformative to financing, supplying and consuming primary energy resources. Yet-to-beunderstood changes to the energy business are coming faster than most people think.


MEHMET OGUTCU: OPEC has for the first time in many decades showed strong production discipline, and this has helped maintain prices in the mid-$50s range. Last winter, OPEC and non-OPEC oil giant Russia have agreed to extend oil output cuts until the end of 2018. The move was heavily signaled ahead of the decision but the oil producers had earlier indicated they could exit the deal if they feel the market was overheating. The deal to cut oil output by 1.8 million barrels a day was adopted last winter by the 14-member OPEC cartel, Russia and nine other global producers. The initial agreement was due to end in March 2018, having already been extended once.Rather than extend the deal by nine months, the group agreed to implement a new deal that will last from January to December of 2018. The agreement does not include U.S. shale oil producers, and there are concerns that rising oil prices, largely thanks to the oil output cut, has allowed U.S. producers to come back online.

NNKS-WPC BULLETIN: Oil Majors and Exploration CAPEX for 2018?

MEHMET OGUTCU: Leading oil majors are expected to increase their exploration capital expenditure by 20 to 30 percent in 2018 and resume drilling in deepwater in a bid to build hydrocarbon-based assets. There would be asset swaps among the majors, with a good level of acquisitions of reserves from medium or small holders in the industry.
Companies are more efficient now having slashed capital expenditures and operational expenditures.Opportunities are there as daily rig rates are at $50,000 to $60,000, down from the $120,000 peak seen several years ago. Deepwater hydrocarbon production and ultra-deepwater exploration will remain in the ground for a longer while. It is only viable at a sustained barrel price of $60 to $65 and he sees 2018 oil prices range between $52 to $58. A price of $60 would certainly bring back the U.S. shale oil on the international market, something OPEC would not want to see.

NNKS-WPC BULLETIN: Geopolitics is back in the equation?

MEHMET OGUTCU: Geopolitical concerns will replace the OPEC/non-OPEC production cuts as the main driver of oil prices this year. Just as the OPEC cuts started to have a tangible effect on global oil inventories, the geopolitical risk premium returned to the oil market last year, first with the fallout from Iraq’s Kurdistan’s referendum and Baghdad’s response to it, which pushed oil prices up on concerns over supply outages from the region. Then the Saudi government’s purge spooked the markets, as well as the heightened tension between Saudi
Arabia and Iran.

The risk is that an open conflict, which Iran and Saudi have traditionally avoided despite all their differences, would spread and hit oil production and trade. The Gulf accounts for a quarter of global production and over 40 per cent of all the oil traded globally. The threat to stability is all the greater given that Iran is likely to win any such clash and to treat the result as a licence to reassert its influence
in the region. We also expect Saudi Aramco’s initial public offering to go ahead in 2018 as planned but there are those who are skeptical about the Saudi oil giant managing to pull off what is expected to be the world’s biggest IPO before the end of the year.

North Korea’s belligerence and Venezuela’s economic collapse and near-default are also some of the geopolitical risks to watch for in 2018.So far, the bearish news of resumed oil flows in the North Sea and Libya has been outweighed by the protests in Iran.Oil prices remained at more than two-year highs as protests swept across multiple cities in Iran.

Crowds of protestors, mainly young people, criticized the government for poor economic conditions. The demonstrations pushed crude prices up a bit, and both WTI and Brent opened above $60 per barrel for the first time in years. Growing unrest in Iran set the table for a bullish start to 2018.

Crowds of protestors, mainly young people, criticized the government for poor economic conditions. The demonstrations pushed crude prices up a bit, and both WTI and Brent opened above $60 per barrel for the first time in years. Growing unrest in Iran set the table for a bullish start to 2018.

NNKS-WPC BULLETIN: China is, off course, an unavoidable ingredient?

MEHMET OGUTCU: The country’s economy is changing and moving away from heavy industry fuelled largely by coal to a more service-based one, with a more varied fuel mix. But the pace of that shift is uncertain and some recent data suggests that as economic growth has picked up, so has consumption of oil and coal. Beijing has high ambitions for a much cleaner energy economy, driven not least by the levels of air pollution in many of the major cities; 2018 will show how much progress they are making.

For the last three years China has managed to deliver economic growth with only minimal increases in energy consumption. Growth was probably lower than the claimed numbers, but even so the achievement is considerable. If the trend can be continued. the result will limit global demand growth for oil, gas and coal. China, which accounts for a quarter of the world’s daily energy use, is the swing consumer. If energy efficiency gains continue, CO2 emissions will remain flat or even fall.

China, the world’s biggest oil buyer, is on the verge of opening a domestic market to trade futures contracts. The Shanghai International Energy Exchange will allow Chinese buyers to lock in oil prices and pay in local currency. There are implications for the US$ well-established role as the global currency of the oil market. The pace of the Chinese state oil reserve stockpiling is likely to ease.

The second Sino-Russia oil pipeline will enable Russia to stake a stronger claim to the growing Chinese crude oil market. This bigger market share for Russia will erode that of Saudi Arabia, whose export volumes ‘will remain under pressure over the coming months in line with the now-extended OPEC, non-OPEC supply cut. The new pipeline, expected to double China’s oil import capacity from Russia to 30 million tons from 15 million tons per annum, will link oil from Russia’s East Siberia-Pacific Ocean pipeline to the Chinese city of Daqing.

NNKS-WPC BULLETIN: There is also electric vehicle’s impact?

MEHMET OGUTCU: Clearly, electric vehicles, robotaxis, and autonomous vehicles sales are at record highs and growing rapidly. Tesla’s Model 3 will gain traction this year, and other automakers will introduce more EV models. China is on the way to become the global leader in EV. Vehicle fuel consumption should see a major decline globally as a result, but it won’t happen for a couple of decades.

While there are a lot more electric cars, hybrids, and fuel-efficient gasoline-powered cars than a decade ago, sales of pickup trucks, SUVs and crossovers due to low prices have taken away fuel economy gains.

We also heard from countries like China, India, France, Great Britain, and Norway—all pledging to ban the sale of fossil fuels to power vehicles on their roads. Electric vehicles could possibly make up 90 percent off all vehicle sales globally by 2050. That would be made up of about one billion battery electric vehicles out on roads worldwide.

Sales penetration into the passenger market will accelerate, creating more uncertainty about future oil demand. Yet perception won’t be reality any time soon; oil demand is rising above the 10-year average. And oil use goes far beyond turning wheels.

Bottom line: Petroleum consumption should drop significantly over the next two decades. But for the next few years, global vehicle fuel consumption will likely continue to increase.

NNKS-WPC BULLETIN: Other unknowns: Compliance with Paris Agreement and renewables?
MEHMET OGUTCU: By 2018 the climate change accord will be three years in the works. The realization will begin to set in that the targets have a high probability of being unachievable – within most countries, and globally as a whole. The biggest unknown to energy markets is what the world governing bodies will do after waking up to this realization.

Renewables, including hydro, accounted for just 5 % of global daily energy supply. That is increasing — solar photovoltaic capacity grew by 50 per cent in 2016 — but to make a real difference the industry needs a period of expansion comparable in scale to the growth of personal computing and mobile phones in the 1990s and 2000s. The problem is that the industry remains fragmented.

Most renewable companies are small and local, and in many cases undercapitalised (though there is a significant shift of capital from fossils fuels to renewables); some are built to collect subsidies. Fast technological transformation brings disruption.

A radical change will be necessary to make the industry global and capable of competing on the scale necessary to displace coal and natural gas.

Falling costs, Chinese dominance and competition in battery technology are some of the main developments to monitor in 2018. The coming year will show us whether it is ready for that challenge.

NNKS-WPC BULLETIN: What is your advice?
MEHMET OGUTCU: There is no simple advice on how to deal with the challenges and capture the opportunities. However, it is clear that companies of the future have to adjust to an opportunistic mindset of competing in a fray of increasing unknowns, instead of seeking solace in overconfident predictions that confirm pre-disposed biases. In short, be skeptical of forecasts; keep an open mind; become more flexible and adaptable.

Mehmet Ögütçü has a 30 year plus track-record of success in government, international organisations such as NATO, IEA and OECD, banking, diplomacy and the energy business. Currently chairman of Global Resources Partnership and Bosphorus Energy Club, and independent non-executive director on the boards of Genel Energy plc, Sisecam Group plc and Saudi Crown Holding, Mehmet is a sought after speaker with a wide breadth of knowledge and experience.

Ögütçü also serves on the international advisory boards of Invensys plc, Windsor Energy Group, The Oil Council, European Policy Forum and Beijing Energy Club. He is the special envoy for Asia-Pacific for Energy Charter based in Brussels. He was recently nominated by the Turkish government for the secretary-general position of International Energy Forum, the world’s largest energy organisation based in Riyadh.

Previous positions that Mehmet has held include: Head of OECD’s Global Forum on International investment, Principal administrator for Asia-Pacific and Latin America at International Energy Agency, Turkish diplomat in Ankara, Beijing, Brussels and Paris, Deputy inspector at Is Bankasi, Turkey’s largest private bank, NATO Research Fellow, EU’s Jean Monnet Fellow, Advisor to the late Turkish Prime Minister Turgut Ozal.

Mehmet studied international relations at the prestigious Political Sciences Faculty in Turkey completing his MSc degree in International Economy at London School of Economics (LSE) and his MA in European Studies at College d’Europe in Bruges. He teaches occasionally at LSE, University of Dundee and Harvard University on energy geopolitics, competitiveness, and investment for development.

Selected reference:
Peter Tertzakian: The Top 8 Unknowns In 2018’s Energy Markets“, Oilprice.com, Dec 21, 2017