Daniel Yergin: Energy industry at its “day of reckoning”

Prominent energy expert Daniel Yergin believes the energy industry’s day of reckoning is here, amid the sudden and unrelenting rush of crude that has drowned oil markets for a year and a half.

This has happened before. In the 1930s, Texas suddenly overflowed with oil. Twenty years after that, it happened in Russia and the Middle Eastern countries. Then, in the 1980s, a tidal wave of oil from the United Kingdom’s North Sea, Alaska’s North Slope and Mexico presaged a ruinous oil bust. Now, the rapid-drilling shale oil producers in Texas and North Dakota that brought on the bulk of the world’s supply growth in recent years are dealing with the self-inflicted wounds of overproduction and high levels of debt.

“This is a rebalancing of the global market, and I think that many decision makers outside and even inside of North America did not anticipate how strong this shale revolution could be,” Yergin, vice chairman of information consultancy IHS and Pulitzer Prize-winning author of “The Prize: The Epic Quest for Oil, Money and Power,” said in an interview.

“There was still a tendency two years ago to dismiss it sort of as a bubble that was going to go away, but this is a change for the oil industry and for this to happen in the United States, the world’s largest consumer, it’s very significant and it has a big impact on markets,” he said. “If this revolution hadn’t happened, we’d be looking at a very different oil market.”

For Yergin, it’s a critical time to set up a dialogue between the world’s most powerful players in energy at the 35th-annual IHS CERAWeek industry conference in downturn Houston, starting Monday at the Hilton Americas-Houston, and running through Friday.

On Monday, Mexico President Enrique Peña Nieto will kick off the conference and OPEC Secretary General Abdallah-Salem El-Badri will share a stage with Fatih Birol, executive director of the International Energy Agency, which advises 29 oil-importing nations. On Tuesday, Saudi Arabia’s Minister of Petroleum and Mineral Resources Ali al-Naimi is set to speak in a rare public appearance, and on the heels of rising speculation that the Organization of Petroleum Exporting Countries and Russia could eventually move to cut production levels.

Such a cut is still unlikely, Yergin said, because of how shale oil has changed the industry. Unlike virtually every other way to extract crude from the earth, shale drilling doesn’t take longer than a few months. It has an average cycle time of 80 days, according to Goldman Sachs, meaning local oil companies can put oil on the market almost as fast as Saudi Arabian oil can arrive in the United States by ship.

That means if OPEC cut production, it couldn’t support prices for long. Higher-cost shale drillers would have an incentive to restart their rigs in West Texas and soak up any market share left behind. In November 2014, OPEC decided not to curb its production.

“OPEC said if there’s going to be some effort to stabilize the market, it’s not just going to be us,” Yergin said. “It was an adjustment to a new reality.”

In effect, the role that OPEC played over the past four decades – as market manager and balancer – is gone. Now, the market manages the market, albiet OPEC could reclaim its market-moving role. But as oil slides below $30 a barrel, it’s unclear whether OPEC will actually try to maneuver out of the slump by negotiating a broad cut with producing nations outside the cartel, like Russia.

Last week, Saudi Arabia and Russia announced they would agree to freeze their crude production if other major exporters joined them. In effect, the oil market’s oversupply would remain in place, but it wouldn’t get worse. Iran, however, has proved the stumbling block to such an arrangement.

Unlike Saudi Arabia and Russia, which were not expected to raise production significantly this year, Iran has recently negotiated its way out of three-year-old economic sanctions through its historic nuclear pact with western powers including the United States. It had lost about 1 million barrels a day in oil production, and it has vowed to reach pre-sanction levels of crude production in about a year. In a parliamentary election year, it’s bad politics for Iran to forgo its share of the market.

“For Iranians, this is a matter of national destiny, to recover their market share,” Yergin said. “They can’t easily back off of that. But the big question is whether Iran is going to be able to put 300,000 or 500,000 additional barrels a day into the market. Until there’s clarity about what Iran is going to do, I think the market is far from frozen.”

Another oil-market element that is often overlooked is world economic growth. Federal Reserve officials recently said they were reconsidering raising interest rates this year because of concerns surrounding global growth. But China’s economy has slowed – its oil-heavy manufacturing sector most of all – as it matures and transitions to a more service-oriented economy. IHS believes the global economy could have “another substandard year” in 2016. It projects China’s gross domestic product could decline to 6.3 percent this year from 6.8 percent last year.

“If we have decent global growth, then it does seem to you’ll see the rebalancing of the market will happen in the second half of 2016 or 2017 and under those circumstances you could see prices in the $40 to $50 range later in the year,” Yergin said.