Stepping away from the pack, Andrew Coleman of Raymond James Equity Research is making a contrarian forecast for an oil glut in 2014. Shale oil production is on the ascent, with the United States joining Saudi Arabia on the supply side, while China's hunger for oil may be sliding and demand in developed countries remains in decline. In this interview with The Energy Report, Coleman explains his thinking and names the producers best positioned to capitalize on the turbulence ahead.
The Energy Report: Why are you expecting an oil glut in 2014?
Andrew Coleman: Because of the evolution of North American shale oil plays, we are on track to add about 3 million barrels (3 MMbbl) of new supply over the next five years. Yet we know oil demand has been falling across the developed nations and is still weak coming out of the global financial crisis. Those developments point toward a glut.
TER: Saudi Arabia surprised you last year by cutting production when oil was more than $110 per barrel ($110/bbl). Why would Saudi or other suppliers not do that again?
AC: What hurt production outside the U.S. last year — and helped keep the demand side a little more in balance — was that Saudi cut 800,000 barrels a day (800 Mbbl/d) in Q4/12, sanctions in Iran reduced exports by about 800 Mbbl/d as well, conflict in Sudan took 300 Mbbl/d offline and the North Sea average was lower by about 130 Mbbl/d. These reductions kept last year's supply more balanced than we thought it would be. Going forward, Saudi's ability or willingness to cut is certainly going to be tested, because by our model the country may need to cut 1.5 million barrels a day (1.5 MMbbl/d), about double what it cut last year. It would have to do that for a longer period of time, given the amount of excess storage that could show up on the global markets.
TER: But, as you just pointed out, Saudi Arabia's cut came in the context of actions by other players. The other players are going to be as unpredictable as they were last year, aren't they?
AC: Certainly. That's a big risk to our call. The other players are very unpredictable as well. I think Saudi has two years of foreign currency reserves at its current spending level. The country doesn't have a deficit right now, so the question is, would it be willing to tolerate a deficit? Most other countries have deficits, but that doesn't mean Saudi will. It is hard to predict because we're dealing with personalities and governments, as opposed to hard numbers. We're going to keep watching, and we'll adjust our forecast if some of those scenarios play out.
TER: Was Saudi Arabia's production cut driven by a policy change?
AC: Saudi Arabia cited internal demand issues in its production cut. The cut may also reflect an adjustment to offset the start-up of Manifa, which occurred last month.
TER: If the glut does occur, which benchmark crudes will be most affected, whether by going up or going down?
AC: In the U.S., production of light oil will dramatically increase due to the shales. Without the ability to export, we are already seeing prices of West Texas Intermediate (WTI) reflecting that "stranded" lighter barrel. We see light imports being backed out of the U.S. as early as this summer as well. Finally, as infrastructure bottlenecks are removed onshore, we see risk to Gulf Coast prices (e.g., Light Louisiana Sweet). With much of the U.S. refinery infrastructure having been geared to process heavier barrels, the large growth in light barrels has already driven WTI prices to a discount with Brent. Risks to Brent could come down the road if European and Chinese demand remains tepid.