In the long-term, forecasters track Supply River feeding Lake
Inventory from the North and Demand River emptying the lake
from the South. While the Shale Tributary has wrought complete
havoc on the short-term market, it simply can’t contribute enough
to the oversupply picture in the long run to prevent the older,
slower moving oil ecosystem from reasserting itself. Supply River
is fed by global upstream spending. Over the past few years,
spending has declined sharply (see Figure 2).
A simple truth exists in the global oil industry: global exploration and product capex drives future production. However, as
we observed earlier, a lag effect exists. Exploration spending
outside of US shale drives production five to ten years from now.
Today, meaningful new supply is coming on line from projects
started years ago in the North Sea, Brazil, Kazakhstan, and the
Canadian oil sands.
So what about tomorrow’s supply? Supply River has a big job
in the long run: it has to replace global declines of roughly 2.5%
per year, and it has to compensate for the growing effect of Demand River, whose flow, as a rule, increases steadily every year.
It surprises most industry observers to learn that global liquids
demand has grown every year for the last 30 with the exception
Some simple math tells us that Demand River grows predictably and steadily in the long run, and that Supply River simply
won’t be able to keep up, no matter what the Shale Tributary
might do (see Table 1).
Why can’t supply keep up when we get into the 2020s? As low
prices choked global capital expenditures, new discoveries in
2015 and 2016 reached lows not seen since the 1940s, when
spending was first tracked. In short, we are at a point today when
the noise from short-term markets is overwhelming, but the
signal from long-term markets is loud and clear.
Some general conclusions can be drawn from that signal. For
most investors, that signal doesn’t have much value. For public
company CEOs, what matters most is the next ninety days. For
hedge funds targeting oil, the near term has enormous importance. After all, a few bad quarters, and redemptions can put a
hedge fund chieftain out of business.
However, long-term trends matter deeply to a subset of the
T1: FUTURE OIL SUPPLY REQUIREMENTS (ASSUMING 2.5% ANNUAL DECLINES, AND 1.0% AVG. ANNUAL DEMAND
(inmmbd) 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Demand 97.7 99.2 100.6 102.5 103.6 104.5 105.5 106.5 107.4 108.3 109.2 110.1 110.9 111.7
decline 2. 4 2. 5 2. 5 2. 6 2. 6 2. 6 2. 6 2. 7 2. 7 2. 7 2. 7 2. 8 2. 8 2. 8
growth 1. 6 1. 4 1. 4 1. 9 1. 1 1.0 1.0 1.0 0.9 0.9 0.9 0.9 0.9 0.8
supplyneeded 4.0 3. 9 3. 9 4. 4 3. 7 3. 6 3. 6 3. 7 3. 6 3. 6 3. 6 3. 7 3. 6 3. 5
4.0 7. 9 11. 9 16. 3 20.0 23. 6 27. 2 30. 8 34. 4 38.0 41. 6 45. 3 48. 9 52. 5
Source: Argus Energy Managers; IHS Markit
investment world. Right now, the 2020s are telling a very interesting story. That’s because by the time the wider world realizes
that we are facing a major supply shortfall in the 2020s, the Shale
Tributary will not be up to the task of balancing the market. It
won’t even be close. Rebalancing markets will be the job of the
Supply River. But as we’ve seen, Supply River volumes take years
to increase. Start spending on a new deepwater project today,
and first oil might be well over a decade in the offing.
We know a few things today: first, new discoveries are at
historic lows. That does not augur well for future supply. Second,
when prices rise in an effort to fill Supply River, it will take years
for those prices to translate into higher volumes. Supply River is
famous for responding to price signals. A sharp increase in prices
triggers an upsurge in activity, today. But that activity doesn’t
deliver increased volume for many years.
In the short run, the Shale Tributary has changed everything.
But as we look into the 2020s, we see supply shortfalls that can
only be filled by a dramatic increase in capex. Today’s oil prices
don’t support that capex. Shale has saved us from high oil prices
today, but ensures them tomorrow. Long-term investors who
take note will certainly profit from this information, but only if
they can separate the signal from the noise.
ABOUT THE AUTHOR
Charles Cherington is co-founder and chairman of
Argus Energy Managers. AEM is a Houston-based
privately held company with equity interests in distinguished boutique investment managers focused
on the energy space. This affiliate network of private
equity firms currently manages, in aggregate, more
than $1.7 billion of committed capital, focused on upstream,
energy services and equipment, and fixed-income
“The forecasters persist in casting bones, reading
tea leaves, and firing up their hard drives because
they are paid good money. Forecast consumers are
inherently gullible. It is a strange world in which willing
consumers consume products defined principally by
their persistent wrongness.”