The Coming Oil Shortage – Part II

The oil price crash on the back of the COVID-19 lockdowns has accelerated the coming supply crunch. Both national and international oil companies have slashed CAPEX and maintenance spending, which will accelerate decline rates, and US shale drillers finally focus on profitability instead of growth. Current longer-dated oil prices are too low to give enough incentive to oil companies to invest in badly needed future oil production. When they finally rise, gold prices will be pushed sharply higher.

In the first part of this report (The coming oil shortage – Part I20 April 2021), we discussed the impact of longer-dated energy prices on gold. We outlined how production from OPEC+, US shale oil producers, and non-OPEC (ex US shale) collapsed on the back of the lockdown induced price crash. In this report, we take a close look at these three sources of oil supply and how we expect production to develop as the world recovers from the pandemic.


OPEC+ production is down because OPEC decided to do so. Production costs for most OPEC producers tends to be very low. Saudi Arabia for example didn’t need to shut in production because it became uneconomical. They shut in because they didn’t want prices to decline even further. But had global prices declined even further, Saudi, and other core OEPC members, would have been the last ones to see prices drop below their operating costs. Importantly for the future, this production can be turned back on the same way it was shut off, as there hasn’t been any meaningful impact on capacity.

However, that doesn’t mean that the COVID-19 pandemic had no impact on the long-term prospects of OPEC oil production. Much like their non-OPEC counterparts, OPEC producers drastically slashed their CAPEX. For example, when Saudi Aramco had its IPO in 2019, the company stated in the IPO prospectus that it plans to spend between $35-40bn in CAPEX in 2020. By March 2020 it had lowered that to $25-30bn. But even as oil prices sharply recovered, Aramco kept revising CAPEX guidance lower. In March 2021 it revised its FY CAPEX target to $35bn from previously $40-45bn, and Aramco is still among the higher spenders among the OPEC countries. ADNOC (Abu Dhabi National Oil Company) revised its 2020 CAPEX down 35%. And while in December last year it celebrated a 5-year spending plan (2021-2025) of $122bn, this was $10bn lower than the previous 5-year plan. KPC (Kuwait Petroleum Corp) announced in March last year that would sharply cut its CAPEX for 2020. The company then announced in August 2020 that it would cut its 5-year spending plan by a whopping 25% by canceling some projects and postponing others, including exploration.

Less is known about the CAPEX plans of the national oil companies in non-core OPEC nations, but given that they are in much more dire financial situations than Saudi Arabia, the UAE, and Kuwait, it’s reasonable to assume that spending cuts will be relatively larger compared to the core members. And while the core OPEC nations rely on their own national oil companies, most non-core members rely on international oil companies to run existing and develop new fields. Many of these companies have drastically reduced their CAPEX outlook (we discuss this further below), including their spending in OPEC countries. Industry consultant Wood Mackenzie estimated last year that international oil companies would cut their spending plans for the African continent by 33%. Seven out of 15 OPEC members are African Nations.

Reduction in CAPEX spending is not the only way future oil output will be impacted. Oil companies drastically reduced operational spending (maintenance) as well. This has a more immediate impact on output than CAPEX cuts. The problem is that reduced operational spending often leads to a permanent capacity impairment. In other words, while voluntary production cuts per see are not necessarily problematic as it just creates spare capacity that can be tapped later when demand returns, reduced maintenance spending can have a permanent impact on a well and production may never return to previous levels. WoodMac estimated last year that some companies operating in Africa cut operational spending by as much as 40%.

On net, while we think that OPEC+ will be able to rapidly fill the supply gap near term with spare capacity when demand returns in 2H21 as normalcy returns. However, the world won’t be able to rely on new OPEC supply medium to long term to meet growing demand. In fact, we think the natural decline of some OPEC members will accelerate going forward. This is a sharp departure from the previous 10 years, where OPEC added 5mb/d of production to meet growing demand. Much of this production was new capacity rather than spare capacity.

Exhibit 9: Since 2010, OPEC added 5mb/d of supply to meet growing demand

Kb/d, OPEC (ex Libya and Iran)

Source: Goldmoney Research

Non-OPEC ex US shale:

Prior to the COVID-19 outbreak, we had argued that 2020 would be the last year of positive non-OPEC ex US shale production growth. Production was expected to grow as projects that had been sanctioned many years ago would finally come online. However, a rapidly depleting project pipeline combined with accelerating natural decline rates would mean that from 2021 onwards, non-OPEC ex US shale would decline in the foreseeable future.

The price crash in 2020 resulted in a production decline already in 2020, as some producers came close to cash costs. Many producers reduced maintenance in their fields, something we had witnessed already in 2008-2009. However, this is a short-term effect. The more important effect is that non-OPEC producers massively slashed their CAPEX. Exxon slashed 30% of their 2020 spending and then a further 11-25% in 2020. BP cut their 2020 capital spending by 25%. The company also announced in March 2021 that it would exit its Kazakh oil projects – an important driver of future growth - and would focus on renewables. BP seeks to reduce its hydrocarbon business by 40% over the next ten years. Shell and total cut their 2020 CAPEX by 20% and announced to transform to a greener business, with Shell aiming to become a net-zero energy business by 2050. While some of these divestitures simply mean that existing assets change from a large oil company to another one, it also means that the companies selling their assets will not invest in new projects.

This means the already dry project pipeline will deplete even faster. This has partially to do with the price shock. But it has equally to do with the realignment of global oil companies towards a greener economy. Many oil and gas majors have announced that they are aiming to invest in renewable energy at the expense of their traditional business. In the past, such announcements were merely more than public relations efforts, but the COVID-19 crisis has probably accelerated the push towards de-carbonization of the economy as well. We expect governments around the world to push for major infrastructure bills in the coming months with a clear focus on “a green new deal”. At the same time, carbon pricing is going global. Energy giants facing the tough decision of whether to invest billions of dollars into fossil fuel projects with lead times often exceeding 10 years and lifetimes of 30+ years. Even though these projects may ultimately turn out to be very profitable, they come with a huge amount of uncertainty tied to the future of fossil fuels. This uncertainty problem is not new and has forced oil majors into the shale sector over the past years, as the lead time is much shorter. But with the current outlook, oil companies are probably not just thinking twice but three times to sanction one of those gigantic oil projects.

As result, we think that non-OPEC ex US shale production has likely peaked and will slowly decline from here onwards. Substantially higher prices (on the back end of the curve) will be needed to incentivize oil companies to make the necessary investments, and even if those investments are made, it will take many years for that production to become operational.

Exhibit 10: Non-OPEC ex US shale production is expected to decline in the coming years

Kb/d year-over-year

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Disclaimer: The views and opinions expressed in this article are those of the author(s) and do not reflect those of Goldmoney, unless expressly stated. The article is for general information ...

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