The key external decision drivers for oil companies with a bearing on their production, growth and financial performance are:
- Quoted crude oil prices,
- Quoted prices of fuels and petrochemical products,
- USD exchange rate,
- Rate of growth of the global economy and world’s leading economies (the US, the EU, Japan, China, India, Brazil and Russia),
- Growth of global crude output in OPEC and non-OPEC countries,
- Production reserves in OPEC countries,
- Geopolitical risks,
- Changes in regulations on greenhouse gas emissions by energy producers and transport operators.
Since mid-2014, this ‘classic’ list of macroeconomic factors has featured two new additions:
- Significant growth of non-conventional oil production (in the US and Canada),
- Exploration and production costs outpacing the growth of market prices of oil and gas.
Those two factors deserve special attention for two reasons. First of all, the supply of oil from unconventional sources has increased substantially, being the key structural reason behind the slump in crude prices in mid-2014. A strong interaction between unconventional oil output and crude price movements results from the super-short production cycle, counted in months, or even weeks and days, rather than in years (as in the case of production from conventional sources). The average time necessary to launch unconventional oil production is only 90 days vs. 3-5 years needed for the development of a shallow water oil deposit or 8 years for deep-water offshore oil production. This has also contributed to the fast-growing oil supply in non-OPEC countries. The other factor is costs of exploration and production activities, currently being the key driver of target crude price which balances the expected demand and supply.
A steep decline in crude prices in mid-2014, followed by a spell of persisting low prices which has continued for over five quarters, put a strong pressure on the significant reduction of exploration and production expenditure and the resulting decline in costs of those activities. Adjustments in the E&P segment of the market are not uniformly distributed across the supply side. After Saudi Arabia revamped its strategy from defending crude prices to preserving the current market share, the supply side of the global oil market split into three segments, each reacting to price signals quite differently. Those varied reactions are reflected in:
- Length of the investment cycle (a shorter cycle for unconventional production, counted in months, or a long, multi-annual cycle for production from conventional sources),
- Ability to finance projects (with a focus on spot prices which determine current cash inflows),
- Degree to which production-related decisions are based on economics.
Onshore oil production in the US (tight oil) is the most price-sensitive segment of the global production market. At the opposite extreme, OPEC countries take production-related decisions based on non-business considerations, such as current needs of the state budget. However, this group is by no means uniform. For instance, Saudi Arabia is able to intensify its production relatively quickly and at a low marginal cost, while still maintaining capacity reserves and a stable production level. Other OPEC countries and Russia produce as much oil as possible at the moment, regardless of the price. The third segment comprises countries other than the US, Russia and OPEC members. The average length of the investment cycle in that segment is 3 to 5 years, just as in the OPEC countries; however, decisions whether to invest in E&P projects are driven by pure economics, based on forecast oil prices expected in several years. Production in the third segment has slowed down, but it is still on the rise. However, the uncertainty surrounding the future of crude prices has forced many producers to defer or downsize many upstream projects, which in turn will affect future supply and prices of oil.