Davos commentary

There was some interesting commentary from Davos from the CEOs of the European integrated oil companies Eni and Total.

"A lot of our projects are long term to have production in five or six years. And that is a problem. If you are cutting capex (capital expenditure) drastically now - we can have a lack of production in four or five years creating a new increased oil price at $200 maybe," Descalzi said (Eni CEO).

Of course everyone who produces and sells oil would like OPEC to cut production to prop up prices.  Oil majors have been increasing capex and their production has been falling for years now, but the independents and state companies have more than made up for those declines.

From a game theory perspective, the goal of OPEC of providing price stability, may be in conflict with the goal of receiving the highest possible price over the long term.  In other industries, the low cost producers never cut back supply, but keep producing through downturns for maximum operational efficiency.  The global mining firm BHP long said that their philosophy was to produce from low cost, long life assets, and maintain production and investment through the entire commodity cycle.  (Incidentally they seemingly diverted from this philosophy when they invested in US shale gas at the top of the cycle).   New producers with higher cost supply will think twice about making an investment if the price can crash from $100 down to $30 at any moment and bankrupt them.  Price volatility can actually be a benefit to the low cost producer because it keeps down supply, and so props up margins, over the longer term.

The only problem with volatility in most OPEC countries is that they use their oil revenue to fund massive social spending programs, which cannot be easily cut back without devastating consequences to their economy.  If, like Norway, they instead put oil revenues into an investment fund, and used the fund to finance their domestic agenda, they could insulate themselves from the volatility of prices.  This may be what the Saudis are doing now.  The only problem, of course, is that there is a long list of OPEC countries that don’t have a fund like this, and have little ability to withstand the short term price impacts.  Iran, Venezuela, and non-OPEC Russia fall into this category.  Iraq has no savings, but they have been able to increase production to partially offset the price declines.

http://www.reuters.com/article/2015/01/21/oil-eni-davos-idUSL6N0V02Z420150121