Exxon and Saudi Arabia Disagree to Agree

Neither one of them really wants another spike in oil prices.
At Closing, May 23th
82.15 USD

Big dogs don't come much bigger than this.

Saudi Arabia’s Minister of Energy and Industry Khalid Al-Falih warned at a conference in London on Wednesday that investment cutbacks in the oil industry today could mean supply shortfalls in future. Speaking immediately after, Exxon Mobil CEO Rex Tillerson said exactly the opposite:

I don’t necessarily have the view that we are setting ourselves up for some big collapse in supply within the next three, four, five years.

You have to admit, Khalid vs. Rex would make an awesome headline for a prize fight. But these two aren't really as far apart as it seems.

Commodity cycles are characterized by booms and busts as companies swing from euphoria to despair, leading to too much or too little investment along the way. Oil's never been immune to this bi-polar existence.

A History of Violence

Real oil prices have rarely offered a smooth ride

Source: BP

Note: Expressed in 2015 U.S. dollars.

So it's only natural that today's trough should set up the next spike; indeed, Al-Falih's comments have been echoed by everyone from the International Energy Agency to French oil major Total (whose CEO reiterated that message in his own remarks after Tillerson on Wednesday).

But while you might think a sudden shift back to triple-digit oil is the stuff of oil-bull dreams, that only holds true if you're a hedge fund. Saudi Arabia and the oil majors are in the market for a much longer haul, with billions of barrels of reserves waiting to be converted into cash far into the future.

Just as his predecessor was warning before he was reshuffled out, Al-Falih must be well aware that the last thing oil producers need is any repeat of what happened in 2008. Besides giving another jolt to disruptive technologies such as electric vehicles, a surge in prices would undermine the efforts to reform Saudi Arabia's bureaucratic economy espoused by the prince who appointed Al-Falih to his job. A price spike would be like taking some sort of opioid: A wonderful high, sure, but probably shortening the industry's lifespan.

So Al-Falih's warning can equally be read as an invitation to the wider oil industry: Invest to save yourselves and us, too.

This is where Al-Falih's warning and Tillerson's apparent insouciance intersect. If a supply shortage is a real risk for later this decade, then the only thing that can prevent it in short order isn't the mega-projects in which oil majors specialize. They take too long to develop (Exhibit A: The Kashagan field in the Caspian, which just shipped its first cargoes after about 16 years of development). Instead, it's shale projects that can be up and running in months. It's the ability to tap these resources, and keep driving down the cost to do so, in which Tillerson has faith.

Whether he is right is the big question hanging over America's shale revolution. The sector's apparent resilience depends in large part on forgiving capital markets, and it is tempting to dismiss Tillerson's optimism as mere Exxonian dogma about the power of engineering to overcome anything.

Still, there is a long history of engineering doing exactly that. And there is little sign of investors cutting off spendthrift E&P companies -- especially now that Al-Falih has talked up prospects of an OPEC supply cut, boosting oil back to $50 a barrel.

Meanwhile, the same day the big dogs were barking in London, over in Houston oilfield services giant Halliburton was reporting its first sequential increase in revenue in its North American business since mid-2014.

We Shale Overcome?

Halliburton's North American business is showing tentative signs of a turnaround

Source: Bloomberg

Note: Quarterly revenue data.

Tillerson has said before that supply from North American shale could suppress oil prices in a way that's analogous to what has happened with natural gas. Given Exxon's problems in Russia, the company's ideal scenario would probably be oil prices staying lower for longer so it can consolidate more domestic shale assets under its own control, through relatively cheap acquisitions, and then applying its own expertise to driving costs down further.

That's no easy pivot for a company built to do much bigger things. For the sake of Saudi Arabia and all the other big dogs, though, they best hope Tillerson's hunch is right.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Liam Denning in New York at ldenning1@bloomberg.net

    To contact the editor responsible for this story:
    Mark Gongloff at mgongloff1@bloomberg.net

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