Emory Corporate Governance and Accountability Review

Low Costs of Oil Prices Impact Energy Decisions: Geopolitics and Investments
Blake Meadows *Smith, Gambrell and Russell, L.L.P, Summer Associate; Turner Environmental Law Clinic, Student Attorney; Emory University School of Law, J.D. Candidate, 2017; Woodruff Fellow; Competitor, Philip C. Jessup International Law Moot Court Competition; B.A. American Politics & Policy, Patrick Henry College. I would like to thank Heidi Hegewald and the ECGAR Executive Board for their help in preparing this project through the entire writing process.

The world has faced declining and low oil prices since late 2014. 1Why the Oil Price Is Falling, Economist (Dec. 8, 2014), http://www.economist.com/blogs/economist-explains/2014/12/economist-explains-4. As oil prices continue to drop and remain low, energy-dependent companies are struggling to meet short-term goals. 2Christian Berthelsen, U.S. Energy Agency Sees Lower Global Oil Prices: EIA Supplies to Grow More Than Previously Anticipated, Wall St. J. (Mar. 8, 2016), http://www.wsj.com/articles/u-s-energy-agency-sees-lower-global-oil-prices-this-year-and-next-1457460188. However, due to the near certain long-term increase in global energy costs, these struggles and low prices should be viewed as temporary. 3Martin Pelletier, Why the Price of Oil Will Recover Faster Than You Think, Fin. Post Bus. (Jan. 18, 2016), http://business.financialpost.com/investing/investing-pro/why-the-price-of-oil-will-recover-faster-than-many-think?__lsa=eac8-646a (Discussing both the production patterns of oil producers and the cyclical nature of oil prices). As companies face the current low prices of oil, they should be careful not to be too shortsighted. Reducing or delaying production of expensive to extract resources may be wise for now but offloading oil assets and infrastructure altogether would be an unwise long-term decision.

Oil prices began to fall significantly in late 2014. 4Why the Oil Price Is Falling, supra note 1. In a matter of months, the price fell by more than 40%, resulting in the lowest prices for crude since 2004. 5Berthelsen, supra note 2. This drop came on the heels of five years of relatively stable oil prices. 6Id. The price slump for crude oil and natural gas has lasted longer than expected, encompassing the first part of 2016. 7Berthelsen, supra note 2. Anticipated oil prices for 2016 are $34 per barrel on average, which is over a 70% drop from the prices in June of 2014. 8Id.; see also Why the Oil Price Is Falling, supra note 1 (the price per barrel in June of 2014 was $115 per barrel).

Several dynamics have continued to contribute to the downturn in price. Despite a host of “peak oil” naysayers in the past decade, current supply is far outpacing demand. 9Michael T. Klare, Energy Wars of Attrition: The Irony of Oil Abundance, The Huffington Post (Mar. 8, 2016), http://www.huffingtonpost.com/michael-t-klare/energy-wars-of-attrition-_b_9408632.html. This excess supply is partially driven by Saudi Arabia’s, and subsequently OPEC’s, unwillingness to cut production. 10Id. The OPEC motive for keeping production high appears to be two fold. First, OPEC has animosity towards the nations that the low prices hurt the most, including Russia. 11Why the Oil Price Is Falling, supra note 1. Second, OPEC hopes to put some of their greatest competition out of business, namely American frackers and other high expense producers. 12Klare, supra note 9. The idea being that fracking and tar sands, which have break-even points between $50 and $80 per barrel respectively, would not be able to survive a $34 per barrel market. 13Id. The results of this low price market have been as expected for high expense producers: they have suffered terribly. 14Id.

There are three questions for OPEC and the world. First, can this price war last long enough to put enough companies out of business that it will make a long-term impact? Second, if it can last long enough to put companies out of business, what does that mean? Third, where will OPEC be sitting at the end of it all?

The answer to the first question is simply that it depends on the individual company. For companies that require constant production revenue to stay afloat, especially in cases of debt, the Saudi tactic combined with Saudi Arabia’s $900 billion dollar reserve will pose a significant problem. 15Why the Oil Price Is Falling, supra note 1. However, for companies who can sit out the slump without active production, this tactic will only delay their profit but will not permanently harm them. 16John Persinos, Energy Apocalypse Deferred: Here’s Your Best Play on Rising Oil Prices, The St. (Aug. 3, 2016), http://www.thestreet.com/story/13486510/1/energy-apocalypse-deferred-here-s-your-best-play-on-rising-oil-prices.html. This ties into the second question, what happens long-term even if the Saudi tactic is successful. The answer, from most people’s perspective, is absolutely nothing. Some companies may go out of business but that does not change the reality of oil presence in the ground. Therein lies the beauty of mineral resources like oil and natural gas: they do not spoil just sitting in the ground. Oil and natural gas reserves are a passive asset and require no maintenance. Whether it is the companies currently in legal possession or another business altogether, the oil will remain ready to produce as long as needed. In either case, production can resume when prices rebound. Which brings up the final question: what does OPEC achieve by overproducing? The answer is relatively little economically. Currently OPEC is motivated by preserving its market share. 17Klare, supra note 9. OPEC may be able to crush production dependent companies out of business for a time but this does not destroy the oil assets in the ground. Wherever one company fails, it will be possible for another company to take over their oil assets. There is no reason why one company is preferable to another from OPEC’s perspective. Long-term OPEC would benefit as much as anybody from high prices. The motivation in this case appears to be more political than economic: a smaller market share means less of a voice in the international community. Economically there is no significant impact from a smaller market share, so long as the oil goes to market.

Long-term, oil prices are likely to recover. Despite Saudi efforts, low prices “are forcing all producers to freeze their production.” 18Nicolas Parasie & Summer Said, UAE Energy Minister Sees Global Crude Markets Correcting Before Year-End, Wall St. J. (Mar. 7, 2016), http://www.wsj.com/articles/uae-energy-minister-sees-global-crude-markets-correcting-before-year-end-1457342783 (citing to statements by United Arab Emirates’ energy minister Suhail bin Muhammed al-Masrouei). The result of the forced reduction in production may be a market “correction” according to some. 19Id. It is clear that many companies still producing oil are losing money, due to low prices. 20Parasie & Said, supra note 18. Additionally, while there is an oversupply, there has not been a reduction in demand for oil. 21 Klare, supra note 9. Indeed, demand for oil has grown, but not as quickly as the supply did when certain fracking and tar sands reserves came into production. 22Id. These factors, taken together with the historical cyclical nature of oil markets, indicate that a recovery will occur in the future: it’s simply a question of time. 23Pelletier, supra note 3.

Saudi decision to flood the market with oil has the potential to skew the investing picture. Low oil prices discourage investment. The problem is that Saudi Arabia ramping up production has resulted in an artificially weak oil market. 24Id. The weak market has been reflected both in terms of crude prices and the investment market more broadly. 25See Evelyn Cheng, S&P, Dow snap 5-day win streak as energy drops 4%, CNBC (Mar. 8, 2016), http://www.cnbc.com/2016/03/08/us-markets.html. Companies are already responding to this weak market in how they are investing in infrastructure around the oil industry. 26See Kevin Mahn, Is Now the Time to Invest in the Energy Sector?, Forbes (Mar. 8, 2016), http://www.forbes.com/sites/advisor/2016/03/08/is-now-the-time-to-invest-in-the-energy-sector/2/#7556cb973c0d. Specifically, there has been a drop in investing in difficult to extract resources. 27Klare, supra note 9. The question then is exactly how should companies handle this artificial market. There are two things that investors should probably do. First, it is likely prudent to delay producing difficult to extract oil because those projects are currently going to lose money. 28Id. In oil this means reducing drilling and delaying wildcat operations. Second, investors should recognize that difficult to extract oil projects will become profitable again when the current oil market rebalances itself. 29Pelletier, supra note 3. Thus, it would be unwise to jump ship on hard to extract resources altogether. One method that could be quite lucrative is acquiring mineral resources but not developing new fields, with the large expense that entails, until a market correction occurs. 30Id. Companies may want to even reduce well unit production on producing wells to pick up the profit of higher prices down the road. The challenge with this is that a company must be able to wait until the market corrects before they will see their investments return. For some companies that proposition simply requires too much cash. For those who can afford to wait it out, this is likely a winning strategy. A prime example is Chevron, which is opting to keep their debt low, making modest investments and waiting out the storm on the premise that oil will rebound. 31Persinos, supra note 16.

In conclusion, it’s a buyers’ market when it comes to unproduced oil reserves. Those with the capital to invest in oil without the necessity of immediate oil profits should potentially consider investing in mineral reserves, as these are likely to gain value in the future. 32Cheng, supra note 25; see also James Paton, After Chevron’s Mega-Project, Smaller is Better in Energy, Bloomberg Bus. (Mar. 7, 2016), http://www.bloomberg.com/news/articles/2016-03-08/after-chevron-s-mega-project-smaller-is-better-in-energy-realm. Similarly, this is not a good time for energy companies to bring new large-scale production on line or to start exploration projects for new fields. 33Paton, supra note 32 (discussing the need for companies to reduce the size of projects and the rate at which they bring resources in to production). Production is currently not where companies should be looking. However, if companies check out of infrastructure investment too far, they may not be able to act fast enough to react to the uptick in price when the market turns around. In the meantime, individuals can enjoy significantly discounted prices at the pump.

Footnotes

1Why the Oil Price Is Falling, Economist (Dec. 8, 2014), http://www.economist.com/blogs/economist-explains/2014/12/economist-explains-4.

2Christian Berthelsen, U.S. Energy Agency Sees Lower Global Oil Prices: EIA Supplies to Grow More Than Previously Anticipated, Wall St. J. (Mar. 8, 2016), http://www.wsj.com/articles/u-s-energy-agency-sees-lower-global-oil-prices-this-year-and-next-1457460188.

3Martin Pelletier, Why the Price of Oil Will Recover Faster Than You Think, Fin. Post Bus. (Jan. 18, 2016), http://business.financialpost.com/investing/investing-pro/why-the-price-of-oil-will-recover-faster-than-many-think?__lsa=eac8-646a (Discussing both the production patterns of oil producers and the cyclical nature of oil prices).

4Why the Oil Price Is Falling, supra note 1.

5Berthelsen, supra note 2.

6Id.

7Berthelsen, supra note 2.

8Id.; see also Why the Oil Price Is Falling, supra note 1 (the price per barrel in June of 2014 was $115 per barrel).

9Michael T. Klare, Energy Wars of Attrition: The Irony of Oil Abundance, The Huffington Post (Mar. 8, 2016), http://www.huffingtonpost.com/michael-t-klare/energy-wars-of-attrition-_b_9408632.html.

10Id.

11Why the Oil Price Is Falling, supra note 1.

12Klare, supra note 9.

13Id.

14Id.

15Why the Oil Price Is Falling, supra note 1.

16John Persinos, Energy Apocalypse Deferred: Here’s Your Best Play on Rising Oil Prices, The St. (Aug. 3, 2016), http://www.thestreet.com/story/13486510/1/energy-apocalypse-deferred-here-s-your-best-play-on-rising-oil-prices.html.

17Klare, supra note 9.

18Nicolas Parasie & Summer Said, UAE Energy Minister Sees Global Crude Markets Correcting Before Year-End, Wall St. J. (Mar. 7, 2016), http://www.wsj.com/articles/uae-energy-minister-sees-global-crude-markets-correcting-before-year-end-1457342783 (citing to statements by United Arab Emirates’ energy minister Suhail bin Muhammed al-Masrouei).

19Id.

20Parasie & Said, supra note 18.

21 Klare, supra note 9.

22Id.

23Pelletier, supra note 3.

24Id.

25See Evelyn Cheng, S&P, Dow snap 5-day win streak as energy drops 4%, CNBC (Mar. 8, 2016), http://www.cnbc.com/2016/03/08/us-markets.html.

26See Kevin Mahn, Is Now the Time to Invest in the Energy Sector?, Forbes (Mar. 8, 2016), http://www.forbes.com/sites/advisor/2016/03/08/is-now-the-time-to-invest-in-the-energy-sector/2/#7556cb973c0d.

27Klare, supra note 9.

28Id.

29Pelletier, supra note 3.

30Id.

31Persinos, supra note 16.

32Cheng, supra note 25; see also James Paton, After Chevron’s Mega-Project, Smaller is Better in Energy, Bloomberg Bus. (Mar. 7, 2016), http://www.bloomberg.com/news/articles/2016-03-08/after-chevron-s-mega-project-smaller-is-better-in-energy-realm.

33Paton, supra note 32 (discussing the need for companies to reduce the size of projects and the rate at which they bring resources in to production).

*Smith, Gambrell and Russell, L.L.P, Summer Associate; Turner Environmental Law Clinic, Student Attorney; Emory University School of Law, J.D. Candidate, 2017; Woodruff Fellow; Competitor, Philip C. Jessup International Law Moot Court Competition; B.A. American Politics & Policy, Patrick Henry College. I would like to thank Heidi Hegewald and the ECGAR Executive Board for their help in preparing this project through the entire writing process.