Citi vs. Chevron: two opposing views of the oil price future

In another of our occasional guest blog entries, Steven Kopits of Princeton Energy Advisors considers the clashing views of Citi Commodities Research and Chevron regarding the likely path of oil prices. Steve can be reached at

The direction of oil prices is once again a hot topic. In a recent Barron’s article, Ed Morse, Citigroup’s head of global commodity research, forecasts a collapse in global oil prices to $75 /b over the next three to five years. By contrast, Chevron has announced that it is budgeting with $110/b oil for 2017, with the company’s CEO John Watson stating, “There is a new reality in our business… $100/bbl is becoming the new $20/bbl in our business… costs have caught up to revenues for many classes of projects.” And for good measure, he adds, “If $100 is the new $20, consumers will pay more for oil.”

Thus, two diametrically opposed views of the future are emerging. The international oil companies (IOCs) have been unable to hold liquids production levels even in the face of soaring capital expenditures and rapidly increasing operating costs. Some, like ExxonMobil and Chevron, are budgeting with $110 oil in 2017 and are expecting that consumers will accept the cost increases necessary to permit the IOCs to sanction new projects.

By contrast, Citi sees cheap oil everywhere, implying either that Chevron and ExxonMobil do not have a solid handle on their cost outlook, or that the IOCs will see the oil side of their business quite literally gutted in the next three years. There is no middle ground here. At least one of these views is radically incorrect.

Citi’s view, which in many ways corresponds to that of BP and the International Energy Agency (IEA), is relatively straight-forward. They all see supply growing faster than demand. For example, the IEA sees supply increasing by 1.7 million b/d in 2014, well ahead of anticipated demand growth of 1.4 million b/d. And this pattern could persist into the future. According to the US Department of Energy (EIA), global oil consumption has grown by 1.3% annually on average over the last decade. Supply, augmented by the substitution of oil by natural gas, could grow faster. Citi, in particular, emphasizes the impact of natural gas substitution over the longer run.

Not all forecasters see supply outpacing demand, at least in the short run. For the 2014-2015 period, the US Department of Energy (EIA) sees consumption increasing by 1.3-1.5%, but supply up only 1.3% in 2014, suggesting continued strength in oil prices. But even this is predicated on OPEC reducing crude production by 500,000 b/d in the coming year to maintain market balance, something which BP also has anticipated.

Such restraint may prove elusive. With the recent surge in Iraqi production and the negotiations to restart Libyan exports, there is upside potential in OPEC supply. Discipline could depend heavily on the Saudis, if the EIA’s numbers are to be believed. Should Saudi goodwill prove lacking, there is a case to be made for Citi’s view.

Chevron’s approach, by contrast, builds on recent oil price history, rising operator costs, and perhaps the need to demonstrate to New York’s equity analysts positive free cash flow over the next several years. Chevron can take comfort in the notion that Citi’s forecasts have been well wide of the mark in the last three years. Citi has predicted prices as low as $65/b in just the last two years; but prices have remained remarkably stable above $105/b; indeed, price volatility is currently at historical lows. In the last three years, anyone betting that tomorrow’s oil price would be much the same as today’s has been vindicated. Thus, Chevron can look back on the last three years and declare that recent oil prices are likely to persist for the next three years. That is not a call on some theoretical basis, but rather one based on the historical track record.

Furthermore, the operators are beset by rapidly rising capital and operating costs. Capex per barrel has been rising by 11% per year, and some operators — Shell, for instance — have been seeing comparable increases in operating expenses. Thus, a traditional (demand-constrained) view of the market would argue that if costs are increasing, sooner or later these will be translated into selling prices. Cost increases are normally passed on to consumers, just as Chevron argues.

It would be comforting if consumers agreed, but in the last two years, oil prices have not risen to offset rising costs, suggesting that the oil companies cannot count on consumers to fully absorb rising exploration and production costs in the future. While Chevron’s price forecast is supportable, hopes placed on the consumer’s resiliency may well prove misplaced.

In short, we see two radically conflicting views of the future, both partially supported and contradicted by the data. Whom should we believe? Is all this just talk, or do the various camps have confidence in their predictions?

There are objective tests which will help us decide. We will know that Citi is serious when Ed Morse declares the IOCs — some of them no doubt important Citi banking clients — to be the walking dead. And we will know the IOCs are serious when they begin to buy oil futures. At present, 2017 Brent futures are trading at $95, even as Chevron and Exxon see oil prices for that year at $110. If they’re right, there’s more money — a lot more money — to be made in drilling for oil on the futures curve than at the bottom of the Gulf of Mexico.

But one way or the other, either Citi is wrong or Chevron is, and by a large margin.

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  1. Jeffrey J. Brown at April 9, 2014 11:27 am

    Regarding tight/shale plays in the US:

    It’s interesting to look at some regional declines in US oil and gas production, e.g., marketed Louisiana natural gas production (the EIA doesn’t have dry processed data by state).
    According to the EIA, the observed simple percentage decline in Louisiana’s annual natural gas production from 2012 to 2013 was 20%. This would be the net change in production, after new wells were added. The gross decline rate (from existing wells in 2012) would be even higher. This puts a recent Citi Research estimate in perspective.
    Citi estimates that the gross underlying decline rate for overall US natural gas production is about 24%/year. This would be the simple percentage change in annual production if no new sources of gas were put on line in the US. In round numbers, this requires the US to add about 16 BCF/day of new gas production every year, just to maintain about 66 BCF/day of dry processed natural gas production. To put 16 BCF/day in perspective, dry processed natural gas production from all of Texas was probably at about 18 BCF/day in 2013.
    Based on the Citi report, the US would have to replace 100% of current natural gas production in about four years, just to maintain a dry processed gas production rate of 66 BCF/day (24 TCF/year) for four years.

    Or, based on the Citi report, the US would have to put on line the productive equivalent of the 2013 natural gas production from the Marcellus Play–every six months–just to maintain current production.

    Or, based on the Citi report, the US has to replace the productive equivalent of all of the 2012 dry natural gas production from the Middle East, in a little over three years (3.3 years), in order to maintain a dry production rate of 24 TCF/year. Over a 10 year period, we would need to put on line three times the 2012 production rate from the Middle East.

    Or, based on the Citi report, in the next four years, the US has to replace the combined productive equivalent of the 2012 dry natural production from Canada, Norway, UK, Iran, Qatar and Indonesia, just to maintain a dry natural gas production rate of about 24 TCF/year.

    On the oil side, if we assume a probably conservative decline rate of 10%/year from existing oil production, in order to just maintain current production for 10 years, we would have to replace the productive equivalent of every oil field in the US over the next 10 years–the productive equivalent of every oil well, from the Gulf of Mexico to the Eagle Ford to the Permian Basin to the Bakken to Alaska. 

  2. Jeffrey J. Brown at April 9, 2014 10:43 am

    The US has–so far at least–shown an “Undulating Decline” pattern in Crude + Condensate (C+C) production since 1970, with 2013 annual US production about 23% below our 1970 peak rate, and we remain dependent on imports for close to half of the crude oil processed daily in US refineries.

    If we subtract out the estimated increase in global condensate production (a byproduct of rising natural gas production), it seems very likely that we have not seen a material increase in actual global crude oil production (45 or lower API gravity oil) since 2005, despite trillions of dollars having been spent on global upstream activity for 2006 to 2012 inclusive, as the annual price of Brent crude doubled from $55 in 2005 to $112 in 2012.

    However, the real problem is the global supply of net oil exports.

    Global Net Exports of oil (GNE* calculated in terms of total petroleum liquids + other liquids, EIA) have been below the 2005 annual rate for seven straight years, with the developing countries, led by China, so far at least consuming an increasing share of a post-2005 declining volume of GNE. Available Net Exports, the volume of GNE available to importers other than China & India, fell from 41 mbpd in 2005 to 35 mbpd in 2012.

    That’s just factual data, but recent research suggests that people frequently refuse to process quantitative data that contradict their beliefs.

    So, while the data show that developed net oil importing countries like the US were, after 2005, gradually being shut out of the global market for exported oil, via price rationing, the conventional wisdom is that we can look forward to an indefinite rate of increase in our consumption of oil.

    I have frequently used the “Midnight on the Titanic” metaphor. Around midnight, after hitting the iceberg, perhaps three people on the ship (about 0.1% of the people on board) knew that the ship would sink, but the fact that perhaps 99.9% of the people on board did not know that the ship would sink did not mean that the ship was not sinking. Later, as the first lifeboat pulled away, the passengers in the boat were reportedly ridiculed by some passengers remaining on board. As a character in a movie from a few years ago said, “Never underestimate the power of denial.”

    *GNE defined as combined net exports from the top 33 net oil exporters in 2005. For more information, you can search for: Export Capacity Index.

  3. Jeffrey J. Brown at April 9, 2014 10:29 am

    If we take the EIA’s global Crude + Condensate (C+C) data at face value (74 mbpd in 2005 increasing to 76 mbpd in 2012), actual crude production, i.e., 45 or lower API gravity oil, could not have increased by more than 2 mbpd from 2005 to 2012, which would mean no increase in condensate production, as global dry gas production reportedly went up by 21% according to the EIA (2005 to 2012), which needless to say, doesn’t seem like a likely scenario.

    I think that a more likely scenario is that actual crude oil production virtually stopped increasing in 2005, as natural gas production–and the associated liquids, condensates and NGL’s–continued to increase, even as the annual price of Brent crude doubled from $55 in 2005 to $112 in 2012.

    Following are estimated* values for global crude oil production (excluding lease condensate), 2002 to 2012, mbpd

    2002: 60
    2003: 62
    2004: 65
    2005: 67
    2006: 65
    2007: 65
    2008: 66
    2009: 64
    2010: 66
    2011: 65
    2012: 67

    Global Crude + Condensate (C+C) production increased at about the same rate as global dry processed gas production from 2002 to 2005, but then we saw a significant divergence between the rates of increase in global gas production and global C+C production from 2005 to 2012, 2.8%/year versus 0.4%/year respectively.

    My premise is that condensate, a byproduct of natural gas production, continued to increase at about the same rate as the rate of increase in global gas production.

    *Assumptions: Global Condensate to Crude + Condensate Ratio was about 10% for 2002 to 2005 (versus 11% for Texas in 2005), and condensate production increased at the same rate as the rate of increase in global dry processed gas production from 2005 t0 2012 (2.8%/year, EIA). Crude oil is defined as oil with an API gravity of 45 or less (per RBN Energy). Data rounded off to two significant figures.

  4. Earl Richards at April 9, 2014 4:34 am

    The backers, partners and the “silent partners” of the IntercontinentalExchange (ICE) in Atlanta rig the oil prices. See the “$2.5 Trillion Oil Scam – slideshare” and Google and read the “Global Oil Scam” by Phil Davis. The US and most of the world are victims of this scam.


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