What happens over the next 12 months may resonate for decades – we provide our view on the pivotal issues that look set to dominate the year ahead.
1. The world adjusts to President Trump
Much remains unknown but there are some potential winners under the Trump administration. His campaign made an issue out of energy independence, further exploitation of domestic oil, gas and coal reserves, encouraging gas demand and job creation in the industry. Keystone XL is likely to get the greenlight and Trump is said to be a supporter of the Dakota Access pipeline.
But his room for manoeuvre may be limited. In terms of encouraging tight oil production, prices will be the primary incentive rather than fiscal measures, with most plays breaking even around $55/bbl. Similarly, gas and coal production are unlikely to be materially affected by government.
A perceived bias towards isolationism could also reshape key geopolitical relationships. OPEC's decision to restrain production did not include Iran, which has been allowed to increase output to pre-sanction levels . Reassessment of US support for lifting Iranian sanctions could therefore materially impact markets – although it's doubtful a Trump administration would have the clout to kill the global deal. The President's developing relationship with Asia will also garner close attention
2. Carbon - which way will the world turn?
A Trump administration may well seek to extricate itself from or ignore the Paris Agreement, which implied a downside risk to hydrocarbon demand growth by promising a cap to global warming to no more than two degrees above pre-industrial levels.
However, energy demand trends suggest greenhouse gas emissions will continue to slow, even without the explicit driver of carbon policy. We believe coal consumption in China has peaked and is in terminal decline, as growth shifts to renewables, nuclear and gas. By 2030, China's greenhouse gas output will remain below peak levels of 2013 and the country will deliver a 70% emissions intensity cut versus a 2005 base year – significantly beyond its Paris commitment.
Whether other countries follow suit depends entirely on cost but a China focused on slowing emissions growth domestically and facilitating change in other markets could be a far more potent force for decarbonisation than the troubled Paris Agreement.
3. Demand disruption
'When is peak oil demand?' is the question dominating the industry. Our base case outlook suggests demand growth will continue, albeit at a slower rate, until at least 2035, sustained in part by growth in petrochemicals.
Solar power has enjoyed a vibrant 2016 and growth should extend into the foreseeable future. But projects that achieved record low prices last year will begin to come online across the world, demonstrating whether they can be profitable without subsidy.
Alongside renewables, electric vehicles (EVs) are the disruptive threat to hydrocarbon demand most often cited. However, even if 'mass-market' offerings do take off, oil demand in transport could still grow. In the US, increased efficiency is driven less by economic decisions of consumers than the federally-mandated Corporate Average Fuel Efficiency (CAFE) standards. With environmental regulation now in question, a rollback on CAFE standards could mean a return to demand growth, pushing global peak oil demand far into the future.
4. Corporate strategies - a muted recovery
We expect upstream investment to increase by 3% in 2017, ending two successive years of decline. US Lower 48 unconventional plays, tight oil and shale gas are highly price sensitive and the nascent recovery at the end of 2016 should accelerate, emboldened by a Trump administration committed to exploiting domestic oil and gas resources.
More conventional projects should achieve final investment decision (FID) – we expect 20 to 25 FIDs in 2017, a marked increase from 2014 and 2015. However, much of the actual spend on these greenfield projects may not come through until 2018. Many of this year's FIDs will be relatively small, short lead-time projects, reflecting the industry's focus on value over volume but there is need for further cost reduction if investment in conventional resources is to restart in earnest.
Exploration success rates and full-cycle returns will continue to improve in 2017, as the industry does more with less capital. The Majors should continue to re-establish their exploration credentials after a long period playing second fiddle to the Independents. Financing M&A will again be a challenge for many E&P companies, particularly outside North America. But a degree of optimism for oil markets after OPEC's u-turn may spur on those looking to do deals while asset prices are relatively subdued.
5. The cartel formerly known as OPEC
OPEC's decision to restrain production had an immediate impact on oil markets, with Brent lifting to well above US$50/bbl. Whether prices can be sustained above the 2016 average of US$45/bbl, depends on OPEC and its non-OPEC partners, as well as the pace of underlying market tightening.
Our fundamental view is that oil markets would rebalance and prices recover in the latter part of 2017 – without production cuts. Demand is robust, whereas non-OPEC supply, mainly US Lower 48, has been suppressed by a lack of investment post-2014. Even with partial compliance, OPEC’s production cuts of 1.2 million b/d, supplemented by 0.6 million b/d from non-OPEC producers, will accelerate the tightening process.
The uplift in prices after the deal is a boost for the upstream industry, especially tight oil producers. Drilling is likely to accelerate, with output expected to return to positive growth after Q1. OPEC's decision is a gift to the very competitor it sought to kill off in 2014 and, by abandoning the market share strategy, it has painted itself into a corner. The group may still be able to control oil prices to a limited degree, but the benefits of that control will accrue to parties outside the cartel. If OPEC remains a functional entity by the end of 2017, its greatest hits will surely be in the past.
6. Populism is the most potent risk for 2017
The tide of populist sentiment that delivered Trump and Brexit will continue through 2017, with major elections in France, Germany and possibly Italy. The primary risk to energy markets is a chronic drag on economic growth as the narrative plays out but sudden shocks can and should be expected over the next 12 months.
While the UK government is engaged in a Supreme Court battle to trigger Article 50, the potential outcomes of the elections in mainland Europe elections are critical. A European Union that fractures either by accident or design could pose a threat to the global economy akin to the Great Financial Crisis.
The prevailing mood should suit President Putin well. With a kindred spirit in the White House, there could be a dynamic realignment of hitherto intractable US-Russia problems, but it's unclear how this could affect Russia's relationship with China. President Xi looks increasingly authoritarian, with anti-foreign rhetoric helping to consolidate power, rather than challenge it. China is unlikely to budge on its ambitions in the South China Sea and will seek to keep negotiations entirely bilateral.
For now, we remain cautiously optimistic that the worst excesses of populist and nationalist sentiment are reined in, as the protagonists succumb to realism and pragmatism. But the risks and real and 2017 could be a delicate year.
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We provide strategic analysis and insight on global trends and geopolitical issues, from supply and demand forecasts across all fuels and sectors of the energy industry, to analysis of evolving macroeconomic trends. Our research into the threats and opportunities for natural resources helps to identify and understand scenarios for key global risks and uncertainties.
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