Silver lining to oil slump
Tony Boyd, Australian Financial Review
December 03, 2014
Who was cited:
Dr. Fereidun Fesharaki
The world should brace itself for a further 20 per cent fall in the price of crude oil to about US$55 a barrel by this time next year, says the man who correctly called the current collapse in prices.
Dr. Fereidun Fesharaki, Chairman of FGE, says Saudi Arabia's decision to maintain production in the face of falling oil prices is part of a deliberate strategy that will fundamentally change the oil and gas markets for the next decade.
The era of US$100 a barrel for oil is dead and gone for at least a decade, he says.
That change in the oil market paradigm will have negative implications for Australian LNG exporters and cause budget headaches for government subsidised renewable energy.
However, in an exclusive interview with Dr. Fesharaki says the collapse in oil prices is good for Australia and its LNG exporters in the long term because all of the planned LNG expansions in half a dozen countries will be stopped.
"The Australian projects, except for a little bit of production out of Gorgon, is all sold," he says.
"The existing ones are all sold and the customers are all reliable customers. But it is all oil indexed so when prices go down it may end up to be taking all your margins away. But you are in long-term business with 20-year contracts and it is almost certain the prices will go up within that period of time and they will get some return. It will not be the huge return they would have if the oil price remained at US$100 a barrel forever."
Fesharaki says major LNG projects in Russia, Canada, Mozambique and Tanzania will be hurt by the oil price collapse.
"The only projects that will go forward are the US projects which are signed and under construction," he says. "Actually, in the scheme of things, high oil prices make people stupid. Low oil prices make you sane. People will make decisions on better analysis, better economics, better engineering and they become more efficient. Longer term its good for Australia but in the short to medium term it reduces stock prices, it makes people nervous and it produces unemployment. People have to adjust to a new world oil order that they didn't know before."
He says Saudi Arabia was for many years happy to be the swing producer that adjusted its production upwards or downwards to keep prices in the range of US$100 to US$110 a barrel.
"The Saudis reached a point where they realised they were facing a losing game," he says. "In 2014, the increase in oil production in the United States is 50 per cent more than the global oil demand growth. Global oil demand growth is about 800,000 barrels per day (kb/d) while US production is growing at 1.2 million barrels a day (mmb/d). While the production in Canada is increasing and in Iraq is increasing while oil demand is muted. The Saudis say the only reason that they can keep the price is by cutting production. But they see Libya was considering increased production and Iran. They had to do something whether it is now, or next year or in two years’ time. The Saudis had to do something which means other people had to participate in reducing supply to balance the market."
He says markets had not understood that the Saudis wanted everyone else to participate in cutting supply but it will take about nine months for the impact of higher production to have an impact in the market.
Fesharaki says the primary oil producers that the Saudis want to target are their OPEC partners. Outside of OPEC they want to target production in Russia and the US.
The Russian production question will rest on the government of President Vladimir Putin but the US is much more difficult because the government has no role.
"The only thing the US producers understand is lower prices and bad economics. So you have to let the price go down to make them suffer. Some US producers can produce at US$30 a barrel oil and some need US$80. So in between we believe prices will go down to somewhere between US$45 and US$55 a barrel and at that level all the growth in US production will due and some of the declining fields will not be replaced. You really need to go to that price and stay there for a year or two - at least a year. But please remember it takes nine months for the cycle to work."
Fesharaki says for the Saudis to really have an impact, the price will have to fall by another $US10 a barrel. That is why there will be no meeting of OPEC ahead of the scheduled meeting in June next year.
The business run by Fesharaki is 30 years old. Its client list in Australia includes all the big oil and gas producers and all the clients of the big LNG exporters in Japan, Korea, and China. He works closely with many governments including Saudi Arabia which, he says, is often misunderstood.
"You have to understand how they (the Saudis) think. It is not likely they say I do something tomorrow and change my mind. At the last OPEC meeting obviously nothing was going to happen because nothing was achieved. The Saudis they think about these things deeply and once they start something they cannot stop until a conclusion is reached. If I were them I would do exactly the same. You have to say OK there is more supply than demand and I am willing to cut but the rest of you must cut too, I cannot carry the burden for everybody."
He says with gas prices on the east coast of Australia at $8.50 and selling for $9.50, life will be difficult for LNG exporters.
He says oil will be back to US$75 a barrel in two years but it won't be back to US$100 a barrel till the middle of next decade. That has implications for renewable energy because the subsidies will be much higher.
"A lot of people who use renewable energy don't know it is subsidised with tax dollars so we need to be much more open and honest with consumers that they are paying huge subsidies to get clean energy."
Potential buyers of the NSW electricity distribution and transmission assets will be much wiser next week when Premier Mike Baird releases the scoping study by Deutsche Bank and UBS. The government said it intends to partially privatise the $25 billion in assets so the scoping study is all about how best to do it.
An initial public offering along the lines of Medibank Private does not make sense because of the huge inefficiencies built into the system from years of sweetheart deals between unions and Labour governments.
There is no point selling the NSW poles and wires based on a one-year price earnings multiple when it will take years for the financial benefits of cost cutting to flow through to the new owners.
The inefficiencies in the NSW network assets were made clear last week in a benchmarking report published by the Australian Energy Regulator.
In its first annual benchmarking report the AER said the privatised South Australian and Victorian businesses were the best performers. The NSW, ACT, Queensland and Tasmanian businesses were not as good.
The AWRO examined operating expenditure and found the Victorian and South Australian privately owned networks were the most productive in the use of operating expenditure. This is because they spend the lowest amount of opex per customer of about $200 each.
The Queensland government owned Ergon had the highest opex spend per customer. It was about double that of Victorian and South Australian networks.
The trick for the NSW government is to make sure the higher profits from increased efficiencies are reflected in the purchase price.
That is possible given that any sale price can be benchmarked against the government's own discounted cash flow valuation.
The potential buyers are sovereign wealth funds, Canadian pension funds, infrastructure fund specialists and Chinese power companies.
The value of the poles and wires will be affected by the ruling last week by the AER denying the networks up to 38 per cent of their claimed revenues over the next five years.