American Oil and Gas Reporter - May 2015 - 153

ed, IEA continues, because more or less
equally sharp corrections have rocked
the market roughly every 10 years since
the price shocks of the 1970s.
"Looking at the medium-term consequences of this latest price plunge, the real
question is not so much how price and supply growth expectations have been reset,
nor whether a rebalancing of the market
will occur-for that is inevitable," IEA poses. "The issue is how that necessary rebalancing and the price recovery that will accompany it may depart from (rebalancing)
that followed similar price drops in the
past, and where they will leave the market after they run their course."

Readjustments
The Report says differences in the
underlying market conditions naturally will
call for a form of readjustment to the price
drop that is different from those seen in
previous market cycles. Usual market
logic dictates that the deeper and faster a
price decline, the stronger the recovery,
while the stronger the rally the more severe the inevitable correction. IEA suggests
market trends favor the latter pattern this
time: The day of reckoning arrived after
years of sustained, record-high prices.
But, based on its analysis, the agency
predicts this rebound will be different because non-OPEC supply has become far
more price elastic than in previous cycles,
while demand has at the same time become
significantly more price inelastic on the
downside.
The result is that, barring any unexpected supply disruption or major energy-related change in policy, the market rebalancing likely will occur relatively swiftly, but
will be comparatively limited in scope, with
prices stabilizing at levels higher than recent lows, but substantially below the
highs of the past three years, IEA forecasts.
It projects the dramatic inventory build of
the past few months will grind to a halt as
early as midyear, and the market will begin to tighten appreciably, resulting in a
steady and gradual increase in the nominal
call on OPEC from 2016 onward.
One of the consequences of the North
American supply revolution is that the presumed high price elasticity of North
American LTO, which itself constitutes the
single-largest source by far of global incremental supply, will limit the usual
overshooting and undershooting of market corrections, both on the up- and downside, the Report says.
The IEA analysis also predicts the
price decline, notwithstanding the sheer
scope of the supply response it already has
dictated, will not succeed in derailing the
underlying forces in motion in the market,
or alter the market's expected course of de-

velopment. The Report says if anything,
pre-existing patterns will emerge reinforced from the adjustment.
Despite market conditions, the IEA still
projects petroleum demand growth will
gain momentum as the global economy
slowly improves, albeit more slowly than
many have expected. The Report forecasts
demand growth, following cutbacks in upstream investments, will run ahead of supply gains by as much as 1.0 million barrels a day over the next six years, resulting in significantly tighter balances by the
beginning of the next decade.
Supply-capacity growth looks significantly lower than previously expected
through 2020, as lower prices slash investments, the Report suggests. Despite an oil
price plunge of more than 50 percent, the
IEA predicts global capacity still will increase to 103.2 MMbbl/d over the next six
years, a 5.2 MMbbl/d gain. Two-thirds of
this growth will come from non-OPEC
producers, the agency holds.
Despite OPEC's stated policy of defending market share, IEA forecasts the
cartel's crude capacity will gain only 1.2
MMbbl/d, an annual average increase of
200,000 bbl/d, with most of that jump coming from Iraq.

Non-OPEC Supply
On the supply side, IEA says the two
top sources of capacity growth identified
in earlier editions of the Medium Term Report-North America and Iraq-loom ever
larger by the end of the decade than previously expected. It says the price correction will cause North American supply
growth to pause, but will not bring it to an
end. By the beginning of the next decade,
IEA predicts, North American unconventional production will account for an
even larger share of the supply mix than
previous forecasts suggested.
Increasing U.S. LTO supply often has
been described as a game changer, the
agency points out. "But its transformative
impact does not derive only from the sheer
production volumes it has unlocked and
which today have made it the world's top
source of incremental supply," the IEA reasons. "LTO also looks set to stand out by
its responsiveness to lower prices. Its
short lead and payback times, rapid welllevel decline rates, and treadmill-like investment requirements make it far more
price elastic than conventional crude.
Price declines already have caused the U.S.
LTO rig count to drop abruptly, setting the
stage for a significantly faster supply response than typically would be expected
from conventional crude producers."
Other sources of non-OPEC supply will
be far more adversely affected by the price
reset; none more so than Russia, which

IEA now projects will swing into a contraction of more than 500,000 barrels a day
by 2020, down from earlier forecasts of
slight growth.
The formidable hurdles facing Iraq, including the challenges of plunging oil
prices and the Islamic State in Iraq and
Levant insurgency, have not succeeded in
slowing its production growth, IEA points
out. By December, Iraqi output had surged
to a monthly average of 3.7 MMbbl/d, a
35-year high, the Report notes. While the
risks to its forecast are considerable, the
agency foresees Iraq as emerging from the
price correction better than its OPEC
counterparts, with a larger production
footprint and accounting for an even larger portion of the cartel's incremental capacity than IEA previously estimated.
"More than ever, caveats apply to this
forecast," IEA advises. "Political risk to
supply will remain extraordinarily elevated in the next few years, both on the upside and downside, after years of chronic disruptions in the oil-rich Middle East
and North Africa region. Lower oil prices
may, indeed, heighten the risk of political
disturbances in countries where social
spending requires higher oil export and fiscal revenues, and buffers are insufficient
to make up for the shortfall, while territorial gains and activism by increasingly aggressive terrorist groups also pose a threat
to supply-not least in Iraq."
However, the Report says lower prices
also offer upside risk to supply. Lower export and fiscal revenues provide incentives
for producing countries to maximize output,
and thus could stimulate production growth
as countries attempt to make up in volume
for per-barrel losses. Downcycles typically lead producer countries to tone down resource-nationalistic policies and thus could,
in some ways, at least ease aboveground hurdles to supplies, the IEA poses.
Iran also may be in a position to increase production and exports rapidly if it
reaches an agreement with the international community over its nuclear program,
which is a possibility that the Report acknowledges it does not include in its assumptions.
Nevertheless, IEA says that for the next
few years, the global oil market looks set
to begin a new chapter, with markedly
changing demand dynamics, sweeping
shifts in crude trade and product supply,
and dramatically changed roles for OPEC
and non-OPEC producers in regulating upstream supply.
"That chapter undoubtedly will not be
the final one, and the oil market and industry will keep reinventing themselves," IEA
concludes. "But it will be profoundly
different from anything that has been
known so far."
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