Oil volatility and instability have haunted traders that guess the market and its trend since the crude price collapse. But taking a long-term perspective, what are the future scenarios? And what is the relation between oil supply and the climate change risk that is captivating the humanity?
The oil price slumped from $115 a barrel last June to approximately $38 a barrel now. The collapse of oil prices has turned the attention of producers towards survival and touched values as low as $28. In the last year oil fell and rose from 28$ to 60$ with daily and weekly oscillations hard to predict and dangerous for traders. Can an investor give oil a chance and put their trust in a such an unstable asset?
Companies tend to discount projected cash flows on the proven assets. Proven reserves require geological and economic conditions that together lead to reasonable certainty of hydrocarbon recovery and viability. On the other hand, for unproven resources, they use the reserve valuations implied by M&A transactions, which as a process creates a higher level of uncertainty.
This elevates the overall risk level of the assets and understanding of supply. Other factors that could lead oil supply to be risky as an asset is regulation, such as carbon caps and a shift to renewable energy. In fact, this is the “systemic risk” which implies the potential for a chain of failures among financial institutions if these risks come to fruition as a result of this renewable transition.
The Long-Term Impact
A sharp downturn in prices has seen oil companies cut spending to the bone and flash almost a trillion dollars of investment in a new project, raising concerns about the long-term impact on supplies and ultimately prices. Saudi Arabia is working with OPEC members and other big producer nations on a deal to curb output and raise prices. Another tumble would surely lead to this supply crunch happening. A potential shortage of supply is not so far in a probability that it could not happen.
Many, including Saudi Arabia’s Energy Minister, share Riyadh’s concern of a supply shortfall in the coming years and Patrick Pouyanné chief executive of French oil company Total is afraid supplies could fall because of under-investment. “We are facing a situation where we do not invest enough; this is not enough to provide the future supply.” Lifetime left estimated for oil is 50 years long. But surely that time will go faster than we think it will?
Alejandro Litovsky of the Earth Security Group was quoted saying earlier this year saying;
“The issues that companies need to consider are multiplying fast: climate change, energy, water and other pressures are reinforcing each other. In 2016, companies will be more aware that this complexity undermines the success of their corporate commitments to sustainability. Now more than ever it is necessary for CEOs to step back and understand the bigger picture.”
Marc van Gerven, vice president of global strategic marketing at rival First Solar, said in 2014:
“Fluctuations in oil prices have little impact on solar or many other renewable energy sources. This is partly why the economic proposition of solar is so compelling, unique and valuable, for example, up to 50% of the cost of a fossil plant is the expense of the fuel over the life of the plant, while sunlight is essentially free.”
In short, the risks of oil supply failing to meet demand seems impossible now. However, the risks associated with financial institutions investing in oil are part of the risks of why supply will fail eventually to meet demand. From clean energy to the inaccurate methods used to determine reserves, it looks increasingly like supply will eventually fail demand sooner rather than later.