Most oil analysts and market observers feel nostalgic this week, as they consider how the global oil market changed in the 40 years following the Arab oil embargo. Citi’s Ed Morse credits the embargo with triggering the largest transfer of wealth in modern history – due to the spate of oil company nationalizations that followed – and another respected analyst, Fereidun Fesharaki, Chairman of FACTS Global Energy, sees the makings of another potential global oil business shakeup.
Speaking at the Center for Strategic and International Studies today, Fesharaki explained how many of the world’s major oil companies may have overinvested in unconventional resource development leaving them precariously positioned should global oil prices decrease, which some, including Morse, anticipate over the short to medium term.
“The oil business is about opportunities and when an imbalance is spotted they go for it, but so does everyone else,” Fesharaki said. “If everybody thinks of the same idea at the same time, it’s a bad idea by definition.” He used investment in US crude oil rail tanker cars as an example of too many people simultaneously pursuing the same investment thesis and thus eroding the economic rationale.
Independent oil companies were first to invest in US unconventional oil and gas production and then major oil companies followed with huge investments like ExxonMobil’s $41 billion XTO acquisition. The higher development costs of unconventional resources versus conventional sources mean a higher oil price is needed to achieve individual companies’ internal rates of return. If oil prices decrease, many unconventional projects fall “out of the money” and get cancelled or put on hold. Look at the start- and stop-nature of Canadian oil sands development over the past 50 years as an example.
Major oil companies made huge unconventional investments assuming prices would remain high, but they all made same bet so are now very exposed to downward price movement, said Fesharaki. Indeed, Shell’s outgoing CEO Peter Voser recently expressed regret regarding the degree of his company’s North American shale gas investments.
Fesharaki talked about the unconventional frenzy, “Buy it because it’s good and buy before it runs out. Independents did it and majors bought it, but it’s now clear investments were too early, look at [the majors’] balance sheets and it looks bad.” There was no fundamental economic basis for these investments, he said, they were faith based-thinking. The market will bail them out with an extended period of higher oil prices.
“For me the economics are good, but if they are good for everyone else, then they are not good overall,” said Fesharaki.
