11 January 2017

The Future Of Oil And Gas? Look To The Past

Chris Ross
WASHINGTON, DC - JANUARY 19: U.S. Senate Energy and Natural Resources Committee Chair Lisa Murkowski (R-AK) (C) talks with Energy Information Administration Administrator Adam Sieminski (R) before a hearing about the outlook for energy and commodity markets in the Dirksen Senate Office Building on Capitol Hill January 19, 2016 in Washington, DC. Many of those who testified before the committee predicted a highly uncertain outlook for producers of traditional fossil fuels like oil and gas while investment in renewable energy sources continues to increase. (Photo by Chip Somodevilla/Getty Images)

In the early days of 2017, it behooves oil and gas companies to reflect on the past, while making plans robust to an uncertain future outlook. There are several questions that should be asked: 

Where are we in the oil and gas price cycles? 

How will politics and policies affect the business outlook? 

What are the appropriate strategies? 

Learning from the Past

It will not surprise any investor in oil and gas and related businesses that theirs is a cyclical business. Prices run up when supplies fall short of demand, hover on the summit for a few years, then tumble as new supply sources are developed and demand growth slows down (Figure 1).

Sources: BP Statistical Review of World Energy; EIA

After the collapse of 1986, oil prices remained volatile through 1990, then declined further through 1998 as production from the Middle East, Norway, Iran and Venezuela increased to meet demand growth and replace declines in Russia and North America. One consequence of the price decline in 1998 was major oil company mega-mergers. These resulted in high-grading of projects, reduction in aggregate capital spending and slowdown in production increases, setting the stage for the run-up in prices after 2002.

The period from 1986 through 2002 can be seen in retrospect to have been a “long grind,” as oil prices were set by the long-term marginal costs of incremental production sources needed to satisfy demand growth and replace declining production from mature oil fields and political turmoil.

Tightly controlled wellhead natural gas prices in the 1970s led to supply shortages. The 1978 Natural Gas Policy Act (NGPA)

started a process of decontrol and broadened the responsibility the Federal Energy Regulatory Commission held over the industry.

In 1985, FERC issued Order No. 436, which changed how interstate pipelines were regulated. This established a voluntary framework under which interstate pipelines could act solely as transporters of natural gas, rather than filling the role of a natural gas merchant. However, it wasn’t until Congress passed the Natural Gas Wellhead Decontrol Act (NGWDA) in 1989 that complete deregulation of wellhead prices was enabled. Issued in 1992, FERC Order No. 636 completed the final steps towards a competitive market by making pipeline unbundling obligatory.

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