ea-mjorlando - nape denver slides - 1610
TRANSCRIPT
Valuation Assumptions
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● our analyses must include a broad range of considerations
sector - wide (macro) project - specific (micro)- economic considerations - technological
considerations- commercial
considerations<--------------- political considerations ---------->
Oil – recent historyCrude Oil Prices
US EIA, data updated September 2, 2016Economic Advisors, Inc., Denver 3
$/bbl
Oil – recent historyCrude Oil Prices
US EIA, data updated February 2, 2016Economic Advisors, Inc., Denver 4
$/bbl
China
housing slowdown
financial crisis
Great Recession
fraccing
OPEC?
Russia?
Venezuela?
Brazil & PreSal?
ISIS?Syria?Saudi
Arabia?
Mexico liberalization?
Iran?
China?
Agenda:
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Political risks in the market for crude oilCommercial / economic factors driving crude oil
markets
Oil – new conventional wisdom
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The OPEC era is past; they’ve lost control of the market.
The US is the new swing producer.OPEC open-taps strategy is targeting shale oil
producers.Saudi Arabia is in a battle for market share.
Conclusion (preview - … the short story):
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OPEC = Saudi Arabia => dominant firm = price leader = monopolist with competitive fringe deceleration and diversification of energy demand (i.e. China) technological advance in competitive fringe (i.e. fraccing)=> increase in elasticities of D and S => [Price – Cost]
markup=> economic / commercial factors => P ≈ $60 to $80 / bbl
Political Risk per reverbations from Arab Spring (2011) risk to control by traditional elites (political, religious) how long can / will Saudi Arabia ‘pay’ (i.e. Poil < $60/bbl) for
advantage in emerging regional political order? how long can Saudi Arabia afford domestic political order?
Agenda:
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Is OPEC a cartel?
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D: cartel = an association of suppliers who coordinate to maintain high prices and restrict competition
pluralnotice competing objectives here and here
OPEC is Saudi Arabia
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How often do OPEC Member States exceed production quotas?
A: all the timeWho has enough spare capacity to control prices?A:
Source: Medium-Term Oil Market Report 2014, OECD/IEA
Price Leader price setting
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Saudi Arabia is price leader dominant firm monopolist with competitive fringe
Price Leader price setting
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What has changed for Saudi Arabia (the price leader)A: on demand side, slowdown in China 2000 to 2010 – China accounted for 40% of
growth in global demand for energy 2010 to 2015 – growth in China energy demand
moderates from 10.5%/yr to 1%/yr 2015 to 2025 – China energy demand growth est.
= 2%/yr (Source: Exxon) 2016 – China oil demand growth < 2% (though
possibly understated per ‘teapot’ refinery output, Source: Platts)
Price Leader price setting
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What has changed for Saudi Arabia (the price leader)?A: China deceleration => optimal price
What risks were present at +$100/bbl oil? will China industrialize as a oil-intensive
economy? Will China consumer demand for energy be highly
oil-dependent? Or highly diversified? Strategic opportunity to influence path of
development?=> optimal price
quantity
price
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Price Leader price setting
S=MC
D
P
Q
MC
MR
Recall monopoly pricing:
moderation in China demand growth
quantity
price
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Price Leader price setting
S=MC
D
Q
MC
MR
Notice P-MC markup is lower with more elastic demand
P
more diversified demand can increase elasticity
Price Leader price setting
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Saudi Arabia is price leader dominant firm monopolist with competitive fringe
China => P for current slowdown & to encourage oil-intensive industrialization
Elsewhere EM softness (x – India) => P Developed economies softness and drop in
energy intensity => P
Price Leader price setting
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Saudi Arabia is price leader dominant firm monopolist with competitive fringe
What about the supply side? traditional competitive fringe = conventional
development (read large-fixed cost development prospects)
new competitive fringe = shale oil
production
($)
fixed costs
total costs
cost structure of traditional basins = high ratio of fixed costs to variable costs:need high P to justify investment, need low P to continue production => inelastic supply
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Price Leader price setting
production
($)
fixed costs
total costs
cost structure of unconventional shale oil = low ratio of fixed costs to variable costs:production declines rapidly, a broad range of P will justify investment => more elastic supply
Price Leader price setting
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Saudi Arabia = monopolist with competitive fringe Supply Side considerations
P in reaction to more and more-elastic supply Demand Side considerations
P in reaction to global economic weaknessP as strategy to discourage elastic mix in demand
But how low should prices be? Shale oil drilling returns at P > $40/bbl, even if short
term Large-fixed-cost investments require confidence P >
$80/bbl for long (20+ yrs?) term=> commercial / economic considerations => P < $80 / bbl
Saudi Arabia price setting
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Economic / commercial considerations can justify prices as low as $80/bbl (or $70/bbl? Or $60/bbl?)
But NOT P ≈ $40/bbl Assume OPEC gain = +2MBPD, but @ $40/bbl = >
+$80M/day But monopolist incurs loss on pre-existing production=> cost to Saudi Arabia = 10MBPD x ($40-$60/bbl) =
-$200M/dayWhat is Saudi Arabia buying with this cost?
A: signal to large-fixed-cost projects – ‘do not invest’ (e.g. Arctic [Shell, Russia], Canada oil sands, Brazil PreSal, Mexico)
?: but once signal has been received, what are they buying then?
Agenda:
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Gulf States divideSunni vs Shia
Ahl al-Sunnah = ‘People of the Tradition’
632 AD – followers of Abu Bakr, friend and father-in-law to Prophet Muhammad
> 80% of global Muslim pop’n > 90% in Egypt, Saudi
Arabia, Jordan, United Arab Emirates
consideration to literal tradition (e.g. Wahhabiism)
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Gulf States divideSunni vs Shia
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Shiat Ali = ‘the party of Ali’
632 AD – followers of Ali, cousin and son-in-law to Prophet Muhammad
~ 10% of global Muslim pop’n significantly in Iran,
Iraq, Yemen, Lebanonconsider ayatollahs as
agents of spiritual precepts
Gulf States divideSunni vs Shia
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Ahl al-Sunnah = ‘People of the Tradition’
632 AD – followers of Abu Bakr, friend and father-in-law to Prophet Muhammad
> 80% of global Muslim pop’n > 90% in Egypt, Saudi
Arabia, Jordan, United Arab Emirates
consideration to literal tradition (e.g. Wahhabiism)
Shiat Ali = ‘the party of Ali’
632 AD – followers of Ali, cousin and son-in-law to Prophet Muhammad
~ 10% of global Muslim pop’n significantly in Iran,
Iraq, Yemen, Lebanonconsider ayatollahs as
agents of spiritual precepts
Stakeholders in Market for Oil
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domestic poli/econ interests
geo-political interests
Russia (producer / price taker)Iran (producer / price taker)China (consumer / price takerUS (consumer / price taker)Saudi Arabia (producer / price setter)
how will key stakeholders influence oil markets as they pursue domestic political/economic interests and broader geopolitical interests?
Stakeholders in Market for Oil
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domestic poli/econ interests
geo-political interests
Russia (producer / price taker)
- efficiencies of scale- needs for hard currency=> Supply
- influence FSU (Ukraine)- influence in Gulf (Syrian naval base)=> Supply
Iran (producer / price taker)
- rebuild economy=> Supply
- security / prosperity via Shia influence in Gulf pro: Bashar al-Assad, Syria; Yemeni rebels anti: Syrian rebels, ISIS Supply
China (consumer / price taker
- diversify to consumer-driven economy- improve environment=> Demand
- Pacific region influence=> ?Supply, ?Demand
US (consumer / price taker)
- improve economy- increase energy security- improve environment-=> ? (not touching this one)
- Gulf region stability- Pacific region influence- climate change=> ?Supply
Saudi Arabia (producer / price setter)
- maximize net returns to fund state Price to $60 - $80 / bbl Supply
- security / prosperity via Sunni influence in Gulf pro: Syrian rebels, Yemeni gov’t anti: Iranian coalitions maintain US as consumer of Saudi crude Price => Supply
quantity
price
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Geopolitical impact on pricing
Secon&politics
D
P= $60 to $80
Q
MC
MR
P= $40
Q
RussiaIran
US
Saudi Arabia
China
Looking forward - oil:
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Looking forward - oil:
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A: they wouldn’t.
A: they wouldn’t.
A: less critical per capital constraints.
A: Yes / No
A: the emerging priority.
A: long-term objective.
Looking forward - oil:
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Outlook:
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Oil: OPEC will curtail production to raise prices as they
confirm Iran is a manageable riskLarge, fixed-cost investments are discouraged fr non-
OPEC producers (Canadian Oil Sands? Alaska? Brazilian PreSal? Mexico? Russia?)
* But look for Saudi Arabia to limit price increase to < $80/bbl
Questions?
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