Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Ask the CEO of an oil company where they think the price of their main product is going, and the usual response is a deeply unsatisfying variation on "I dunno."

That isn't the main reason why Royal Dutch Shell PLC's chief executive drew a collective gasp with his "lower forever" comment about the market last week. But it is worth remembering when it comes to interpreting what Ben Van Beurden meant.

There's a good reason why oil chiefs tend to shy away from public prognostications on the subject: They can get it embarrassingly wrong.

So it shouldn't be a surprise that when Van Beurden talked about oil being "lower forever", he didn't actually mean forever-ever:

Lower forever; yeah, that's the mindset. Yeah, to be perfectly honest, I do think we will have quite a bit of movement in the oil price going forward, and there is a better than 50-50 chance that we will see oil prices trend up ... But that's not the mindset that we want to have in the organization. We do not want to have the mindset that higher oil prices are around the corner to help us out. 

Yeah, could go down, could go up, could stay about the same, right?

Van Beurden wasn't trying to predict the oil price. He was trying to do something much harder: instill a culture of thrift inside a giant oil and gas company. This is about resilience, not clairvoyance.

Shell, like its peers but more so, went on an investment binge when oil prices were in triple digits, with capital expenditure peaking at $40 billion in 2013 alone. As so often in the commodities business, all that spending on new supply helped touch off a crash, leading to a predictable effect on returns:

Returning To Earth
Shell's supercycle spending combined with a crash in energy prices trashed its returns
Source: The company
Note: Data for 2017 are for the first half of the year.

All oil companies have of course scrambled to cut costs amid the downturn.

But Van Beurden's "lower forever" comment tells you that, as an aspiration at least, this isn't just about laying off some contractors and putting cheaper coffee in the staff room.

The original sin of the oil business is its long-standing assumption that, even if it occasionally lost its head in a boom and suffered in a subsequent downturn, demand would always go up, taking prices with it. A project's net present value might end up looking like a car crash, but it would at least generate cash flow for future spending and dividends at some point.

This is what "lower forever" really means -- not that prices will never go up again (Venezuela's slide toward further sanctions and chaos is just one reason why oil could go higher from here). Rather, it's that, even if prices do go up again, the company won't chase them with bigger budgets and ever more supply just for the sake of it.

Because with shale boosting supply at sub-$50 oil prices and long-term demand growth no longer a sure thing, the cycle may not be there to bail out an exuberant major. Being competitive is all that counts.

As part of this, Shell aims to move away from complex, one-off megaprojects where, unlike in America's shale fields, there's less payoff in terms of productivity gains. Standardization, a mantra long touted by oilfield services contractors such as Schlumberger Ltd., is the objective.

Shell's exit from Canada's oil sands -- the ultimate in megaprojects levered to oil prices and infinite demand -- is another example of fundamentally changing the business model rather than just cutting costs.

It isn't certain Shell will stick to this, of course, although it has shown solid progress over the past year. In fact, it will take an upswing in oil prices to demonstrate whether the company can resist temptation.

But it is important nonetheless, in part because Shell isn't the only oil major, or even the biggest, to be taking steps down this road.

Saudi Arabia's oil minister talks about doing "whatever it takes" to juice oil prices using the same old OPEC playbook -- in part because he has, by definition, a starring role in the extended road show ahead of the Saudi Aramco IPO.

But the very fact that shares are being sold in Saudi Arabian Oil Co. as part of a wider reform program for this oiliest of economies tells you that, even if it isn't being said in public, Van Beurden's "lower forever" comment has certainly crossed more than one high-ranking mind in Riyadh.

As I wrote here, Saudi Arabia's only viable strategy for dealing with the new dynamics of oil supply and demand is to cut its own costs (or, more precisely, ensure it can thrive even if prices stay around $50 a barrel or lower). Unlike Shell's boss, banking on a return to the good old days wouldn't just risk trashing Saudi Arabia's financial health but potentially derailing its society altogether.

If Saudi Arabia can pull it off -- an "if" orders of magnitude bigger than the one concerning Shell -- then it can reach a place where it can use competitive muscle, rather than Viennese conclaves, to prosper in the oil business for a while yet.

The corollary, of course, is that even if "lower forever" isn't a firm price prediction, it's a philosophy that would create its own reality.

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