Investec London – Charles Whall on why the oil price won’t stay low forever

Now that all eyes are on the oil price, it is a fine time to focus on what really drives those prices. Yes, supply and demand, but a lot more besides. Charles Whall, portfolio manager at Investec Asset Management in London explains the very fine balancing act between production, capex, supply and alternatives in that space. It is a fine balancing act indeed, but his belief is that the oil price is going up. – CP

GUGULETHU MFUPHI:  According to Tom Nelson and Charles Whall, Portfolio Managers at Investec Asset Management, the oil price is unlikely to stay this low for an extended period of time.  Charles joins us now on the line to explain why.  Charles, perhaps if you can justify your outlook on the oil price not taking a dip further.

CHARLES WHALL:  Okay, well I’ve been looking at these oil markets, working in the oil markets for over 30 years, and I don’t think I’ve ever seen a greater dislocation between the perception and the reality of the markets.  In reality, we have an oversupply of around one-and-a-half percent, at the moment.  Remembering the oilfields deplete naturally at ten percent per year, so it doesn’t take much change in the capital spend to see a correction in the production.  What we are seeing already is, particularly in North America, a very rapid reduction in Capex, so where we are believing that OPEC’s seeing one-and-a-half million barrels over supply this year, we’re seeing that, very quickly within the, we’ll see a correction to a balanced market.

It doesn’t actually take a balanced market for the oil price to start to move but as soon as people see that North American’s supply is moderating, we can expect the oil price to firm and start to move forward.

ALEC HOGG:  Charles, what do you make of the Goldman Sachs’ report this morning, where it’s looking at a barrel of around $40.00 a barrel, before there’s any impact on shale production?

CHARLES WHALL:  Well, I’m afraid that we would disagree entirely with what they’re saying.  We’re already seeing a recount come up.  We’re seeing an eight percent reduction, just over the last month.  So there’s no better metric and you’ve got to remember that with the unconventional production, with the shale production, it’s a capital intensive and immediate production effect.  So, these wells are drilled within and brought on, within one month, and then we see production come on at 1000 barrels a day for a well but it falls within the first six months, to well below 500 barrels per day.  So you have this rapid decline coming on.  We also, what Goldman is omitting is that this year is a particularly poor year for new development.  This is why the oil service companies have been suffering for a while because we have very little new production coming on.

In fact, a million barrels per day less new production this year, than we saw in 2014.  That’s a dramatic reduction and we don’t think that’s in their numbers.  They are not reservoir engineers.  They are petroleum economists.  My background is in reservoir engineering and  understanding how these oilfields produce and they seem to be using metrics that are for conventional production.  Not metrics that are pertinent to either deep water or the unconventional, so we see a much larger decline rate.


  So what average price would you be writing in for 2015?

CHARLES WHALL:  We have an average price of between $70.00 to $75.00, for Brent, so it’s around a 40 percent upside to today’s price; a 40 to 50 percent upside to today’s price.  The way we see that running is that we anticipate that by the end of February we’ll see sufficient rig count decline to stop the oil price falling and then by the end of the second quarter, if the oil price hasn’t risen, we do expect OPEC to step-in faster than the current indicators.  Their next meeting is in June, to stabilise the oil price.  What they are trying to do, the Saudis’ objective here is to take capital out of the system, for North American shale investment.  That is happening much faster than they anticipated.  So we can see that OPEC, once they’ve illustrated the vulnerability of shale production, and we’ve been talking about this for three years now.  These shale projects, they need a very high oil price on average, to break even.

ALEC HOGG:  But what about the other side of the coin?  That you can also just cap the shale project until the oil price gets back to a level where you can switch it on again.

CHARLES WHALL:  Well, there is an element of truth in that but I think this is a major wakeup call for those that are providing cheap capital into shale.  I think they’ve been, the information that’s been available has been significantly incorrect, with the terms that people are expecting from these shale provinces, do not take into account the underlying costs of getting the acreage, and of tying these wells in and of the decline.  We’re really thinking that we’re going to find it less easy to fund a lot of these marginal shale properties, but it will, sort of reduce in reduction in the investment and therefore, the growth from shale.  We do need shale to balance the books, so it is not as if this is something that needs to be completely marginalised.  We very much need US Shale to balance the books, going forward and we also…  We had the major cutting back Capex over the last 12 months.

We have a period of very low additions from conventional fields, over the next, well three to five years, where we can see projects coming forward are in a very low relative, to historic norm, expiration performance from the major oil companies has been diabolical over the last three to four years.  Where they have had some success has been in natural gas.  In terms of crude and liquids, we are very short once we get past 2016 and 2017.

ALEC HOGG:  Charles, just a final question.  Clearly, so far, the only shale gas explorations have happened in the United States.  They are not the only parts of the world where shale is able to be brought to the surface, or shale gas can be brought to the surface economically.  How much of that have you worked into your calculations, in other word, China, South Africa, Australia, Chile, bringing in their shale production?

CHARLES WHALL:  Right, so we looked at this extensively and the only other place where we’ve seen any commerciality from liquids, from shale oil, is in Argentina.  So the Chinese have tried, the Russians are not incentivised by the fiscal regime to do that.  That’s a longer term and sanctions have really ruled that out, really for the next five to ten years.  Where we’re seeing shale wells, the shale have been cooking there for 200-million years.  Most of that oil is broken down into natural gas, so there’s plenty of natural gas but not enough liquids.

ALEC HOGG:  Fascinating insights there from Charles Whall, Portfolio Manager at Investec Asset Management.  Talking to us from London and, as he says, he’s an engineer and the guys from Goldman Sachs are petroleum economists.  Well, we’re heading into a short break.  More Power Lunch after the break.

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