Oil is hitting an 'invisible price ceiling'

An oil worker stands by a rig near Williston, North Dakota.
Brad Quick | CNBC
An oil worker stands by a rig near Williston, North Dakota.

The often accepted paradigm that crude prices are cyclic and it is only a matter of time before we see a sharp rebound is being disparaged by the ruthless realities of energy markets. Low prices and less volatility are likely to continue.

The age of cyclicity may have already ended due to a shift in energy fundamentals including concerns about global warming. It is true that compared to other commodities such as gold, platinum, copper or coffee, crude oil has exhibited a higher degree of volatility going back several decades. Since 1996 crude prices have fluctuated as much as seven-fold, peaking at $148/barrel in mid-2008.

Gold, platinum, and copper followed similar trends, albeit with slightly less varied responses. Hopes for a rebound in prices before year-end are fading. Even for 2017 prospects for Brent crude firmly above $50 are less than 50/50 barring a production pullback by OPEC and Russia or a "black swan" event affecting global markets.

Some experts will argue that geopolitical factors vastly differentiate oil and gas imparting an unavoidably high volatility to market pricing. That may well have been the case historically but the future promises to be different. The reasons – a confluence of three factors, namely growing crude supplies, increasing alternatives to crude (including gas and renewables), and a softening demand for fossil fuels dampened by climate concerns on one hand and energy-efficient consumers on the other.

We are witnessing the genesis of a clean energy ecosystem that is more market-driven and less susceptible to nonmarket forces than ever before. The defining characteristic of the new ecosystem is that it is based on a competitive platform of "clean" kilowatts. This does not mean the end of OPEC or super-majors, only that they have to compete in a far more crowded, mixed, and diversified field of energy providers.

"We are witnessing the genesis of a clean energy ecosystem that is more market-driven and less susceptible to nonmarket forces than ever before."

The source of these kilowatts – oil, gas, wind, solar, or clean coal – matters less. (The power grid fueling electric cars blurs any distinctions). Affordability and public perceptions of environmental harm matter most. Advantage light oil, wind, solar, and gas. Bad news for conventional coal and tar sands. Thus the real battle being waged by and within OPEC will be as much about the crude's share in the total energy pie as what share each country will have within the global oil basket. What it means for oil is an invisible price ceiling that is well below its past peaks.

The U.S. combined daily oil and gas production at 21.5 million barrels a day equivalent for the first half of 2016 is virtually unchanged from a year ago despite a steep drop in oil prices, a testimony to the resilience of the industry and the ever-present impact of technologies. Thus the shale producers of West Texas (and by extension, the U.S.) are setting a high benchmark for OPEC, Russia, and other players. The future energy markets (and the proxy wars associated with it) will demand yet higher efficiencies in every facet of delivering clean kilowatts.

Agility in adopting new technologies will separate winners from losers. In the global geopolitical energy arena this gives the U.S. an edge given the innovative DNA of its economy. A most relevant advantage that must be recognized by policy makers in the Trump and Clinton campaigns. By the same token, state-owned enterprises (within OPEC and beyond) will have no choice but to emulate fast-adoption of new technologies to maintain their market share in energy. No room for laggards.

The oil and gas industry's contribution to global GDP is estimated to be nearly $10 trillion, yet it lags behind other industries such as IT, auto, and aviation in embracing the digital revolution. Of more than 1.5 million active wells estimated worldwide (1 million in the U.S. alone), only a miniscule fraction are equipped with real-time monitoring systems that enable real-time decision making capability to improve efficiency or profitability of wells.

What's more – on a global scale including the U.S. – the industry's "artificial Intelligence" and data-mining capabilities to smart-up decades-old, manual processes to manage oil and gas fields are pedestrian compared to Silicon Valley based enterprises. State-owned companies that account for the lion's share of worldwide oil and gas output fare even worse, albeit with exceptions. In short, the industry on the whole suffers from an information-technology gap. In a high-price environment, this would be tolerable.

Not so in a low-price, cut-throat energy era. The oil and gas industry will undoubtedly close this gap as a matter of survival. The ultimate impact is yet better economics for extraction.

Today's markets values a cup of gourmet coffee typically at a price multiple of eight to ten-fold compared to premium gasoline (of equal volume) at the pump. What future markets will choose to value gasoline versus coffee depends on so many variables, many hard to predict. As the German philosopher Goethe noted, "Character is constructed in the midst of the tempests of the world."

The oil and gas industry worldwide will have to show "character" to excel in an open-ended, low-price, extreme-efficiency environment. The fight for clean kilowatts is on. This is good news for consumers everywhere. And bad news for those who are solely banking on high prices and hoping for tail winds of high volatility.

Commentary by Nansen G. Saleri, president, CEO of QRI, an oil investment advisory firm with expertise in oil and gas reservoir management.

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