Low Oil Prices: How Did We Get Here and Where Are We Headed?

Monday, February 23, 2015
CDIC/Courtesy Reuters
Edward L. Morse

Global Head of Commodities Research, Citibank

Katherine B. Spector

Head of Commodities Research, CIBC World Markets

Howard K. Gruenspecht

Deputy Administrator, U.S. Energy Information Administration

Betty Liu

Editor-at-large, Bloomberg Television

Introductory Speakers
Michael Levi

David M. Rubenstein Senior Fellow for Energy and the Environment and Director, Maurice R. Greenberg Center for Geoeconomic Studies, Council on Foreign Relations

Howard K. Gruenspecht, deputy administrator at the U.S. Energy Information Administration, Edward L. Morse, global head of commodities research at Citibank, and Katherine B. Spector, head of commodities research at CIBC World Markets, join Bloomberg's Editor-at-Large Betty Liu, to discuss the history and future of oil prices. The panel remarks on the factors that have led to current oil prices, domestic and international production levels, and forecasts for this year and beyond.

This meeting is part of the Geoeconomic Consequences of the Oil Price Plunge symposium, which is presented by the Maurice R. Greenberg Center for Geoeconomic Studies.

LEVI: Good afternoon. Welcome to this Council on Foreign Relations Symposium on the Geoeconomic Consequences of the Oil Price Plunge.

I'm Michael Levi. I am the David M. Rubenstein Senior Fellow for Energy and the Environment and director of the Maurice R. Greenberg Center for Geoeconomic Studies here at the Council on Foreign Relations.

Welcome to all of you in New York, to our members and guests joining us by video conference in Washington, D.C., and to everyone tuning in our our livecast.

The oil price crash is the sort of subject that the Council, with its presence in New York and Washington and our geoeconomics center, with its focus on the intersection of economics, international relations, and foreign policy were born to grapple with. Whether we're looking at the causes of the crash, which combine market and geopolitical forces or the consequences which touch the world economy, international security, and the global environment, understanding the oil price crash demands a wide range of expertise and insight. And that's just what we have for you today.

This symposium is one of many ways that CFR is grappling with the changes that are sweeping global energy. To name just a few others, fellows have published research over the last few years examining oil price volatility, the risks of lower prices, and looking at the potential consequences. More recently, fellows have been publishing articles and studies on everything from Saudi strategy to the impact of the price crash on the U.S. economy and Mexican politics. And you can find all of that and more at CFR.org.

Foreign Affairs has also been publishing regularly on how the market is changes and on the consequences. And just two weeks ago, Blake Clayton, who until recently was a fellow here and is now an adjunct fellow, published a new book, Market Madness: A Century of Oil Panics, Crises, and Crashes, which is both as timely as the title suggests and exemplifies one of the things we try to do here. It provides depth and context that help us understand world events. I encourage you all to buy it, or at least to leave a five-star review on Amazon.

I'm excited for today's symposium. We have three fantastic panels lined up that together are designed to help us get at this nexus of markets, economics, international relations, and foreign policy. The first will explore how we got to where we are in the oil market and where we might be heading over the coming months and years. The second will debate the economic consequences of those developments for the United States and the world. And the third will look at the resulting geopolitical fallout and at how policymakers ought to respond.

I am tempted to claim that we started planning this symposium a year ago with extraordinary foresight into where the market is now. That would be a lie. It would also be rather unfair to the extraordinary team in CFR's meetings department that has pulled this symposium together so quickly in the face of unfolding world events. And I particularly want to thank Kate (inaudible), Stacy La Follette, and Nancy Bodurtha for their leadership and dedication to making this symposium a success.

I'll rejoin you later this afternoon to moderate the third panel. But for now, I'd like to turn things over to Betty Liu, editor at large for Bloomberg Television, to get our first panel started.

LIU: Thank you so much. Is my mike on? Hello.


LIU: I'm going—everybody sit down first before I start. Ed, please.

Thank you, Michael. And thank you to the Council on Foreign Relations for inviting me to moderate this panel. I have to say, I was telling the CFR folks that I've not gotten so many responses to my moderating this panel than—than this one; meaning that I got a dozen emails from friends, colleagues, associates who said oh, you're doing this oil panel. I'm going to be there, I'm going to be listening. So everybody is interested in where oil is headed.

So before I begin, I want to introduce my panelists this afternoon. Ed Morse is sitting to my left. He's the global head of commodities research at Citibank. Katherine Spector is the head of commodities research at CIBC World Markets. And joining us from D.C. is Howard Gruenspecht. He's the deputy administrator for the Energy Information Agency.

Howard, I just want to check you can hear us.

GRUENSPECHT: I can hear you.

LIU: OK. Perfect. Wow. Technology works. OK.

So Howard, I actually think—you know, Ed gave me this idea. I actually think we should start with you.

GRUENSPECHT: My good friend.
LIU: Right. Exactly. And you're away from us. So if we don't agree, you don't be able to see us disagree with you.

You're kind of the official word—or you are the official word on where oil markets are headed and where oil prices are. So I want to get your take first on where we will end up in oil, your best prediction by the end of 2015.

GRUENSPECHT: Well, thanks for that question.


First of all, let me say—I do have to say since maybe not everybody here knows EIA, you know, we provide—we have a mandate to provide independent data and analysis. We don't, you know, take views on policy issues. That work is not subject to review by either the Department or other federal agencies; and therefore, should this venture into policy which I won't, our views shouldn't be construed as representing those of other agencies or the administration.

So with that, I will stop dodging. Even though I'm in Washington and filibuster. You know, we have a published outlook. It's—it's been actually—we publish every month a short-term energy outlook. The number we have, you know, penciled in for a Brent crisis for 2015, average is $58 a barrel. At the time we did that at the beginning of January, I think, you know, many people thought it was too high. You know, it looks fairly good maybe now.

But the real story here is that the markets are telling us there's just tremendous—you know, if you look at the values of futures and options contracts, you can see that—that people with money in the game just see a very wide range of—of uncertainty about this. So what looks like it might be good today may well prove to be wrong. I mean, for December 2015, the range we see based on futures and options prices kind of goes all the way from $30—to get a 95 percent band of the market expectations, you'd be going from $30 up to $112. So—and I think that tells you something. We all have to be modest.

LIU: It tells us a lot.

GRUENSPECHT: Including you, Ed.


LIU: Over to you, Ed.

MORSE: No, he said "including"; that I had to be modest.

LIU: Oh, I see. Well, Ed, so let me—let me just bounce off what Howard just mentioned. Because you put out this report a few weeks ago, grabbed a lot of headlines—Bloomberg went in a tizzy over it—where you said look, might we see $20 oil and this may be the end of OPEC? Explain.

MORSE: Sure. Well, the $20 was kind of taken a little bit out of context.

LIU: Oh, OK.

MORSE: Not a lot out of context. But I did say it, so I won't back away from that.

We think the market is going to be significantly weaker by the second quarter than it has been so far this year. We think the market has responded to false signals about whether the market has bottomed. A lot of financial flows have ended the market on the assumption that the market has bottomed one way or another.

Fundamentals speak in a different manner. U.S. oil inventories, one thing we can measure—Howard's group does a spectacular job of doing it—are growing at a rate of about a million barrels a day. And they're growing at that rate because imports are continuing. Partly because some of our—some of the countries that export to the U.S. have no other place to export. That includes Mexico and Venezuela, partly because U.S. production is still growing at a rate of about a million barrels a day annualized.

But a lot of it is because we're in a season of refinery maintenance and the world is actually really oversupplied. And the great visibility of it is production growth in the U.S. and—and inventory growth in the U.S. We think this inventory growth is going to continue through a weak second quarter. And the fact of the matter is we're running out of storage capacity in the U.S.

EIA publishes numbers on shale capacity. They talk about why a lot of this is working inventory. Tank tops are reached, but you never go to tank bottoms. You need 15 to 20 percent of oil in that. And we're seeing the indication of U.S. reaching tank tops in the market. That's why WTI, our major traded crude in the U.S., has separated from Brent, a more worldwide marker. That's why the so-called (inaudible) to spread between the prompt month and future months has widened; because the economics of storage are well in play.

And it's hard to know where the price goes down. But it does go down as you reach tank tops. We can't do much more after you reach tank tops, other than to shut in production. And the $20 number came from what we considered to be the average cost of operating or producing from marginal fields in the U.S., including shale resources, which have a $25 average cost of operating. So the logic is that when you reach tank tops, you then start storing because it's cheaper to store than it is to produce. The value of the oil in the ground is higher than the value of the oil produced.

Globally, we have a little bit of excess inventory and ships that have been charted for floating inventory. The economics of that don't really work. The spread between the prompt month of Brent and the deferred price is not as wide; not wide enough to yet allow for the cost of storage to be carried.

We think after the second quarter, demand will pick up. We think supply will start to shrivel from other places. So we think the market reaches its logical bottom in the second quarter, a lower price than today. Maybe $15 lower on average than today. And then it rises towards the end of the year as the global economy improves a bit, as demand for oil improves, and as supply is taken out of the system. So we're looking to a price at the end of the year for Brent in the $60 range, rather than where it is today in the $50 range.

LIU: How about you, Katherine?

SPECTOR: Well, I'm not quite as bearish as Ed is, but I do agree with a lot of things he said; in particular, about the trajectory over the course of the year. Our global fundamental balance looks a lot more constructive in the second half. And I don't think we're necessarily out of the woods yet in terms of the downside of price.

As Ed sort of alluded to, over the last four to six weeks or so, we've seen a tremendous amount of retail investment money actually come into exchange trade of products and oil, and I think that that did give us a bit of a false bump here. What we see in the past is that often that retail money is not necessarily the best at picking the tops and bottoms, but always tries. So—so I think we do have a bit of a false rally here, and probably another traunch lower before we reverse in a more compelling way.

One sort of subtlety of our view that I would point out is that we see a big difference between WTI and Brent right now. Fundamentally, when—all the talk about all the stock building that's happened over the last year or so, that has been disproportionately in the United States, as opposed to in Europe and Asia. So while the global balance does look quite soft in the first half of the year in particular, in terms of what the market will have to work through in terms of the inventory that's built up, that is very disproportionately in the United States. So our WTI Brent spread has already widened in front of the curve to about $10 dollars, and I think it could certainly widen further.

Beyond Ed's second quarter projection, I would just point out that even beyond that, in the fall season, refinery maintenance looks like it will be quite heavy in the U.S. mid-continent, which is bearish for WTI at a time when we see our global supply and demand for crude actually starting to look better. So even then, I think we could continue to see that differential widen as the year goes on.

LIU: So who—so who's going to cut production first, then? I mean, there's got to be some point, right, when production gets cut? So who's going to cut first?

SPECTOR: Well, I do think it will be supply that—that responds to price before demand. But I don't think it will necessarily be U.S. supply. And I think that the risks that other producers have right now is that this price decline could actually make U.S. producers stronger. It gives them an opportunity to think about efficiency and optimization and cost-cutting. I think it is actually some of the older fields in other non-U.S. countries, cash-strapped non-U.S. countries, that may actually see a more meaningful supply response to this price before the U.S. does.

MORSE: Yes. I think we're going to see a response in the U.S. We have this wonderful term called "stripper wells" that are wells that produce less than fifteen barrels a day. There's about 330,000 of them in the U.S. that produce one barrel a day. Those of us who have lived in Oklahoma see pumps in a lot of people's backyards. There are 147,000 of these pumps in Oklahoma that produce one barrel a day or less. There are 220,000 wells in the U.S. that produce between two and five barrels a day. A lot of that is uneconomic and will disappear from the system.

A lot of talk now about the U.K. There's an article by a former BP official in the Financial Times today about U.K. production. This is also marginal. There are a lot of fields in the U.K. that are producing because it is better for the balance sheet of a company to produce rather than to bear the costs of taking these platforms apart. These guys from BP at least are at least arguing now that the costs of abandonment are lower than the costs of production. Because the production costs of producing a little bit out of that much capital deployed are huge. There are estimates that maybe 200,000 barrels a day of fields producing in the U.S. and the U.K. could be shut in by the end of the year because of earlier-than-thought abandonment.

LIU: But—but none out of that's going to have a major impact on—


MORSE: Oh, I think if you add it up, it'll have a major impact. You—you probably are going to see a 1 percent increase in the decline rate across the globe. That's a kind of funny number. But it means that 800,000 to a million barrels a day more in 2015 and '16 than in 2014 and '13 have to be replaced before you get a growth in supply. That's because at the margin, companies abandon fields. They abandon marginal wells.

And then there are special cases beyond the U.K., like Columbia and Brazil and Venezuela and Nigeria and Russia where, combined, you could probably have enough supply shut-in to really balance the market and get a boost in prices.

So I think Katherine is absolutely right; the world is overestimating what the contribution of the U.S. shale producers are likely to be. But the rest of the world has plenty of supply to contribute to a better balanced market.

GRUENSPECHT: Right. And the other part of—I mean, balance, of course, is at—while I completely agree with Katherine that, you know, demand may not be very responsive to price, you know, the world economy is still growing and—and demand is responsive to that.

And again, so in our outlook, I think we're looking for a million barrels a day year-over-year demand growth between 2014 and 2015, and another million barrels a day year-over-year demand growth between 2015 and 2016. I think some of the—you know, the IEA is a little bit lower in 2015. I think Ed is a little bit higher. Some others are a little bit higher than Ed, even. You know, I think Ed's was as 1.3 million.

But, you know, we're talking really about—you know, these are changes in levels that are, like—you know, we're starting at about ninety-million-barrel-a-day market. So we're—you know, a million barrels a day of demand growth over the course of a year, you know, does eat into it. It's not just a supply story. Although, again, the increase in demand is not just driven by—is not driven mainly by prices. It's driven mainly by the—by the growing economies.

Now, I think one of the big uncertainties in the price outlook is how strong demand growth, you know, looks over the next year, over the next two years. And again, that'll depend as much on the global economy as it does—as it does depend on price changes.

On the supply side—again, you have to be—it's tricky when you're looking at numbers. So we see year-over-year growth slowing down a little bit from the—in the U.S.—from the kind of million barrels a day per year that we've experienced the last couple of years. We're carrying right now, 2015 over 2014, at about 700,000 barrels a day increase for the U.S.

But a lot of that has already happened. If you look at the—you know, because again, all through 2014, monthly production was steadily rising. So if you take the average of 2014 and compare it to the average of 2015, even though 2015 production in the U.S., you know, is not that much of an increase over what it was in December 2014, then year over year you still get an increase. But again, we're not seeing a tremendous, you know, increase from the level of December or January over the course of 2015.

You know, I—I agree with my colleagues that at least in the United States, certainly the lower 48, which includes both the stripper wells that Ed was mentioning and the shales, you know, are the most price-sensitive. I mean, Alaska is in a secular decline down. And the Gulf of Mexico, which has much longer-lived type of projects, I mean, we think that's actually—production is going to be sort of continuing to rise there by virtue of investments that have been locked in for some time.

But we do see some responsiveness of, you know, lower 48 production. We have some quarters where lower 48 production actually falls off a bit. But that is going to be more sensitive to the—perhaps more sensitive to the price environment. So our outlook for shale production would be tied in to our outlook for prices.

LIU: You know, before we—before we move on about sort of the forecast on oil, I mean, one—one question that I—that I haven't been able to get a really good answer on—you know, before we talk about where we go—is how we even got here in the first place. I've never gotten one consistent answer as to why we are here in the $50s with Brent. Why? What happened in the middle of last year that brought us to where we are? What happened?

MORSE: I'm happy to start. You know, we're used to understanding the way elasticities work. We're used to understanding that—and we've seen this through our price spikes. Because the relationship between demand and price is so sticky, inelastic, it needs a very high price increase to ration demand when you're in a tight market. That's why we saw price spikes in 2008 and other periods in the past.

We have not seen this happening on the supply side, where there still is a stickiness; that is to say you need a relatively-dramatic drop in prices to get supply rationed, because we've had this organization called OPEC. And OPEC has intervened to make sure that the market is not been required to ration supply, but it rations supply for the whole as a whole.

I think there are, with that background, a couple of things, three observations to make about 2014. One is, the world economy didn't grow the way people thought it was going to grow. And the result was demand was a lot weaker than people thought it was going to be. And the difference was around 700,000 barrels a day between official forecasts of demand in the IEA OMR and what the end of the world demand was. About 700,000 barrels a day with an eight or nine basis point difference in GDP growth.

The second is a supply-side factor; namely that the first half of 2014 was a time when the Atlantic Basin—which has a lot of light sweet crude, the kind that we produce in the U.S.—moved from tightness to balance to oversupply. And that's because the shale revolution in the U.S. rejected enough former imports of light crude from the other side of the Atlantic Basin that the Atlantic Basin became a glut. And you can see this in the structure of the Brent forward curve, where prompt prices were higher than deferred prices until—until May/June, when it flipped into flatness. And then by July, when the Brent market is normally very tight, it flipped into weakness, and the structure with prompt prices lower than deferred.

So I think this was really the sign of the geopolitical disruption of the shale revolution on global markets and on global geopolitics. And the third factor—

LIU: Let me just stop you there. The glut on that—the second aspect, how—describe the glut.

MORSE: Well, the glut can be seen in both the structure of the Brent forward curve, but in the—in the inability of West African producers, who produce Brent crude, to actually sell their crude.


MORSE: To sell it at any price. They used to be selling at a premium to Brent. Then they went flat, and in some cases to discount. This was a sign of a glut in the market. It's only fifteen or sixteen million barrels a day of a ninety-three-million-barrel-a-day market, but there's not a lot of refineries that want that light crude. There are a lot of refineries that want heavier, more sour crude. So that's the kind of the geopolitical challenge of the U.S. shale revolution which, by the way, will not go away, even as this market tightens itself by sometime next year.

The third factor was the Saudi decision based on what I think was the Saudis confronting an existential crisis in their markets; their decision not to cut production, but to fight for market share. And it's a kind of very easily understandable dilemma that they were in. If you look at a country marketing seven million barrels of oil a day, their two largest markets—the U.S. and China—in the fall of 2013 were markets that were absorbing 2.8 million-barrels a day of their 7-million-barrel-a-day sales. And by the summer of 2014, that 2.8 million barrels a day of sales had fallen to 1.6 million barrels a day of sales and actually—by the winter, got even lower than that.

So if you're in the market of selling oil and you've lost a big market share in the two biggest markets in the world, you want to do something about it. And they decided that they were going to fight for market share, even if the price went very low, and let the—let the cards where they go in terms of other suppliers who would have to pull back.

LIU: So all that together though, Ed. So those three factors would equal how many millions of barrels of oil a day? And does that equal a 50 percent decline in oil prices?

MORSE: Look, the decline in oil prices, you can't measure by, you know 1.5 or 1.2 or even 0.8 million barrels a day of surplus. You've got to look at the margin. So where the market cannot at the margin absorb something, the market has to balance it.

And that's why I started my remarks by talking about something easily understandable. In a tight market, you need a price spike to ration demand and cut it off. And in a weak market, you need a low price to ration supply and cut it off. That's a very difficult problem to overcome quickly unless, as we typically have had, OPEC intervening to short-circuit that pain, to short-circuit this deep sweat that a market has to undergo in order to drive down supply. OPEC has short-circuited that, protecting their own revenue. They opted not to do that this time. So you needed a very unusual steep drop mirroring what would otherwise be a steep increase or spike to balance the market.

SPECTOR: Just to add to what Ed—


SPECTOR: Sorry. Go ahead, Howard.

GRUENSPECHT: No, go ahead, please.

SPECTOR: Just to add to what Ed was saying, last summer, in a way, some of those initial variables are in retrospect sort of mundane given—given the price decline that we've seen. But last summer we also went into that period of a weaker Atlantic Basin light crude market that Ed was alluding to with a paper market that was very, very long in crude. I would say lopsidedly long in crude. So at that time, we had a market that was very lopsidedly positioned in what turned out to be quote, unquote, the wrong way. So as the market started to get weaker in the Atlantic Basin on a fiscal basis, I think that those financial flows sort of doubled down on—on that. So the fiscal fundamentals, in other words, determine direction. By sometimes magnitude and velocity can also be influenced by those paper flows.

The other thing that I would add is that our last five years in oil were so incredibly range-bound that I think in a lot of ways, the market got a little bit complacent. And there's a reason that the market was range-bound. And a big part of it was down to the Saudis keeping it range-bound. And not only their willingness, but what I would argue, that they did a better job of it than they ever had in the past. So we were in a very, very range-bound market. And I think that when the Saudis essentially advocated that role of market manager, that meant that the market had to decide what will the next quickest thing be that will modulate supply and demand. And nothing will be as quick as the Saudis doing it.

So I think part of what we're seeing now has been a price discovery in terms of how long will it take and what will the price—what's the price that's required to rebalance the market. After this period where the Saudis did it so quickly, who will our next quickest thing be?

LIU: Howard?

GRUENSPECHT: Well, I—I again find myself in—I don't want to say violent agreement. I'll say peaceful agreement, because this is the Council on Foreign Relations.

But, you know, in terms of the Saudis keeping things range-bound, I guess another thing that was kind of—because U.S., you know, light tight oil had been growing at a pretty significant rate over the last few years. But the number of sort of unplanned outages in places all over the world had also been really rising dramatically, which I think had also had an effect of masking some of that.

I actually think in the middle of 2014, you know, when ISIL first, you know, I think took Mosul in Iraq or something, there was a concern that oh my God, this is going to put, you know, Iraq's major oil production in play. And I think that's actually the point at which things really kind of hit their—hit their peak; I think in June of 2014. I'm trying to remember.

Then obviously, you know, the way the Iraqi situation kind of works, the oil's in the south and it's not where ISIL is or has gone. And, in fact, Iraq's oil production has really been sort of extremely strong toward the end of 2014. Libya went through a period—Ed was describing the light market getting glutted. Libya went through a period—you know, they clearly are nowhere near where they were, you know, in the Qaddafi era. But they had been down almost around zero, one of these large forced outages, and then all of the sudden last August/September, you know, they got up for a couple of months, did 900,000 barrels a day. And that's, again, that type of light oil that Ed was talking about. Now they're back down again—
LIU: Right.

GRUENSPECHT:—but, you know, you see some of these kind of movements going on.

But one thing I would want to say say, sometimes in this conversation I hear discussion of OPEC, and sometimes I hear discussion of OPEC decided this and that and the other thing, and then sometimes it's more about what Saudi decided. And, you know, I think that's a really interesting question.

You know, in a world where what's available to OPEC members as a whole, you know, in the market, you know, when you have a couple of, I think, OPEC countries with pretty—you know, very high-quality resources. I mean, Iraq has very high-quality resources. Iran has, you know, pretty high-quality resources. They've kind of been out of the game for, like, thirty years, for various reasons; you know, beating each other's brains out, we're beating their brains out, you know, they're internally beating their own brains out. Whatever it is. You know, but—but there's some kind of—

I'm wondering whether some of what's going on has to do with sort of down-the-road signaling, you know, within, among these countries, you know, who do not function as a—

LIU: Well—

GRUENSPECHT:—as a—as a strong cartel.

LIU: That kind of raises—that goes back to the point that was raised in one of Ed's reports, whether this may be the end of OPEC as we know it.
LIU: Ed? Or Howard?

GRUENSPECHT: I wouldn't say that. I—I think the countries with the low cost—I think—you know, these are the countries with the lowest—I think the core OPEC countries that have the lowest cost, the best resources. I mean, in the end, you know, they have a very significant role to play, I think, you know, in the global oil market. A lot depends on how—on how—they're in a very—you know, they are collectively in a very strong position. But I'm not quite sure that sorting out among themselves is—is completely worked out.

LIU: Then before—Ed, before you respond. Because this is something that we talked quite a bit about when we were at Bloomberg a few weeks ago—or excuse me—a week ago with some oil analysts; which is essentially, when is there the chicken-out point? You know, when is the point when somebody finally says, you know, Saudi Arabia or the U.S. oil producers, when they chicken out and they—and they cut back? It's a different number for Saudi Arabia than it is for U.S. oil producers, than it is for other countries that are in much bigger pain than any of the other two that I just—that I mentioned.

So what is the chicken-out point for Saudi Arabia and where is it for the U.S.? Anybody want to tackle that?

SPECTOR: It's not clear to me that we'll get to that point for Saudi Arabia. I think that other—other supply-side factors will—will align in such a way that—that we won't get to their chicken-out point.

But I think one other thing that we forget about with Saudi Arabia, we think about Saudi Arabia a lot in the sense of who would be willing to cut production in a loose market environment. But what the Saudis have done for the last five years is that they have unilaterally within OPEC increased supply to market when the market needed it. And they did that really without anybody—any help from any other OPEC members. So I think from their position, they're thinking well, when the market needed more oil we did that all by ourselves, nobody helped us, why should we give it all back unilaterally now? And that's a fair point.

So for some of the other OPEC members, ironically, many of them are producing near or even below what their last known quotas were in 2010. So I'm not sure we can really expect a whole lot from those other producers in either direction.

LIU: Ed?

MORSE: Yes, I think there's something more fundamental going on. I think what we're witnessing in part—and this is why I don't hesitate to talk about the end of OPEC—is the failure of the petro state, where the resource curse has finally reached its logical conclusion. And I think we're seeing OPEC members being separated by those who can make an accommodation to a post-oil environment or an environment in which they can diversify their economies and provide for government and legitimacy without the oil price going up.

And I think part of that dilemma is a view—and I know I'm the first to criticize people who talk about the end of history or 'never again'. But I think there are plenty of reasons to believe that we're not going to see oil prices at $100 or higher for a very, very long period of time. And if that is the case, then there are going to be countries that will suffer fragmentation risk, like Libya has; there are countries that are going to suffer more violent forms of, for lack of a better word, implosion, like Venezuela currently is.

And there are very few countries in OPEC that have the ability to do what Bahrain and Dubai successfully done; namely, diversify their economies. I think the Gulf Arab states are certainly in a position to meet the challenge of diversification in a way that other countries like Ecuador and Venezuela in this hemisphere really don't have the luxury of doing.

So with that, I think the decision-making cohesion of OPEC is really no longer there. And I can foresee a time in the next half-decade when countries in OPEC will be willing to accept the pain of a production cut on a prorated basis, which means the Gulf countries and the three of them in particular, with a little help from Qatar. But Saudi Arabia, Kuwait, and the Emirates are the only countries in a position—and it really is Saudi Arabia at the end, because the others are marginal—to decide how they want to use their surplus production capacity and how they might want to curtail production to suit their own views of their longer-term revenue objectives.

LIU: Howard, before I turn it to Q&A with the audience, do you want—do you want to chime in here?

GRUENSPECHT: No, not really. I'm interested in the Q&A.

LIU: OK. So we're just at the halfway mark. And I just want to remind everyone that these comments are on the record. So everything you say can and will be used against you. And feel free to—to raise your hands, ask questions. I want to get—

Dan, yes. Please.

QUESTION: Thank you, Betty. Fascinating conversation.

One of the elements that I didn't hear from any of the panelists is the dimension of the relationship between Saudi Arabia and Iran as to whether or not Saudi's actions on supply are targeting Iran and maybe even Russia as much as they are the U.S. shale producers, which you talk so much about. I'm wondering if you could address that, please.

SPECTOR: I mean, it's my view that the Saudi strategy is targeting other OPEC members and probably Russia primarily. And (inaudible) gain some data points on these U.S. producers is sort of a bonus. But I think that this is far more targeted to the other OPEC members.
MORSE: Yes, I think there's a lot of public commentary on how the Saudi announcement of a change in policy was not accidentally timed to the U.N. General Assembly meeting last September and the high probabilities waged—or oddsmakers were putting on the P5+1 one or the U.S. and Iran coming to an agreement on—on nuclear talks. 
From what I read in commentary, I would say it appears clear that the Saudis look at the pain inflicted on Iran and Russia as an added bonus, rather than the direct target. Although, when I was—in December, so after the OPEC meeting, on a trip to the Middle East where I met with senior local officials, not expats, in the other GCC countries and Saudi Arabia; they all pointed their finger at Iran being the major target. That was their interpretation. And I think it's by happenstance that the Saudis can enjoy whatever pain is inflicted on both Russia and Iran.

QUESTION: (OFF-MIKE) I guess what I was—


QUESTION (OFF-MIKE):—pointing to is the potential that there's something going on here Sunni/Shia that is even more than incidental. There's a geostrategic ploy.
MORSE: Undoubtedly, the Saudis have used their oil weapon, which is to produce more, at times when they're confronted existential threats. And, you know, there's plenty of evidence from public records in the Reagan library that the U.S. and Saudi Arabia conspired to punish the Soviet Union for the invasion of Afghanistan. There's plenty of evidence that in 1997, the Saudis increase production in order to punish Venezuela for stealing their market share in the U.S.

So there's plenty of historical evidence of a government, once confronting existential—perceived existential threats, that they will use the instrument of foreign policy that they have available to them. That's not inconsistent, I think, with their believing that the oil market itself was the major target of what they were doing by refusing to curtail production in the fall.

GRUENSPECHT: Right. I mean, given the EIA's role, I wouldn't draw any, you know, notion about what the Saudi's objective might be.

But the only comment I would make is that, you know, inherently, the U.S. shale producers make sort of a poor target. Because, you know, inherently, that's a very, very quick, short-payout investment process. You know, there is obviously some laying down of rigs going on. The rigs can easily be picked back up, you know, when the—when the time comes. So the notion that somehow you can—you can systemically change the economics or the availability of something like shale oil over the longterm with a—with sort of a short-term price drop, I don't think would really hold up. So I wouldn't imagine that that's what they were trying to do.

It's very different if you're talking about, you know, people who are investing in projects that take a decade to bring to fruition and cost tens of billions of dollars. You know, you might cause people involved in that kind of activity to rethink that activity. And again, as I think Katherine pointed out, you know, when something persists for three or three and a half years, people think of it as the new normal. But, you know, hundred-dollar-a-barrel oil was actually sustained, is actually pretty damn unusual by historical standards. So there's a lot of talk about how we've broken from the norm. But the norm is a very recently-established norm.
SPECTOR: I think that that's an important point. It was actually just right before prices collapsed that our five-year trailing average oil price had just crossed $100. And we really don't know what that sort of sustained period of high oil prices did to a lot of things; to supply elasticities, to demand elasticities, really even to foreshadow our next panel, I guess, the relationship between oil and the economy. A lot of the work on that was last done in the '80s. So I think part of what we're seeing here is a bit of a grand experiment; what will a period of lower oil prices do across the board?

MORSE: I'd like to just make one additional comment on what Katherine and Howard said. I think there is an experiment. And I think the Saudis may be doing part of that experiment. Shale production has grown in the U.S. by roughly a million barrels a day per year for nearly four straight years. Some of this may have been the result of irrational exuberance. Some of it may have been the result of a lot of capital flowing into production activities that were never going to be profitable.

And I think we'll see when prices rebound what the level of growth of U.S. production might be. I wouldn't be surprised if it's not a million barrels a day per annum. I wouldn't be surprised if there is a flushing out of unproductive investment in the U.S. unconventional oil sector. So I wouldn't therefore be surprised to see a rate of growth of a half a million barrels a day, rather than a million, just to put a number on it. Which would actually change supply-demand balances going forward somewhat.

LIU: OK. I want to take a question from our members in Washington, D.C. And if you can stand up and identify yourself, that would help a lot.
GRUENSPECHT: I'm deputized to act as moderator in Washington.

QUESTION: Thank you. I—I just have a comment. Two things need to be corrected. In order—

LIU: OK. First off, could you identify yourself for us here in New York?

QUESTION: Yes. Yes. Odeh Aburdene, the Capital Trust Group.

When we talk about OPEC, we should realize historically, OPEC has never been cohesive. You know, Iran and Iraq had a war. There's a proxy war going on in the Middle East today. So this notion that OPEC is cohesive and this is the end of OPEC; OPEC has been living on and off, half a life, a full life.

Two, when it comes to Saudi Arabia, the notion that the Saudi policy is driven by revenues only, that's false. If you go to the 1980s, after the Iranian Revolution, the Carter Administration, the Reagan Administration, asked the Saudis to increase production. It wasn't in Saudi interest to increase production and lower income.

So when it comes to Saudi oil policy, there are geopolitical factors. And when we talk about Saudi Arabia, we shouldn't talk about Saudi Arabia as an Exxon or a Mobile, nor as a Chase Manhattan bank. That's my comment.

LIU: OK. Did everyone hear that?

LIU: Howard, we were—Howard?


LIU: We're having a little bit of a hard time hearing him here.


LIU: Could you—

GRUENSPECHT: OK. I think it was more in the form of a comment than a question. So maybe we should take one other one? Is that—but please—

LIU: OK. Let's do that.

MORSE:—make it a question, I guess. So—yes. Yes.

QUESTION: Thank you. My name's Chris Mahony. I'm from the Center for International Law Research and Policy.

GRUENSPECHT: Can you speak loud, please?

QUESTION: Based in Brussels, but I'm also a visiting fellow here at Georgetown Law Center.

My question is really the inverse of what you were discussing in terms of the extent to which the Saudi position affects Russia, affects Iran. What—what would you hypothesize were, say, the United States to reach an agreement with Iran: how might that change in your view the Saudi position towards the oil market, if—if at all?

You know, may they then perceive a potential realignment of the United States in the Middle East, or perhaps a pivot towards Iran in relations? And how might that, in your view, adjust their thinking and then their approach to the oil market? Thanks.

GRUENSPECHT: Did—did my colleagues in New York get that? Because that doesn't seem like a good EIA question.


MORSE: I would just note, as Katherine's about to answer the question, that Katherine and I live by these funny rules where we have to say when we speak publicly that we're going to be consistent with whatever we've published before. And then if we publish a one- or two-page report, that's followed by five pages of little tiny words that say don't believe a thing that this person has said, don't make any decision based on what these people have said, and nobody is going to take responsibility for anything you do based on whatever they say.

LIU: OK. On that note—on that note, go ahead.

SPECTOR: Thanks for cheering me up on that one, Ed. He's like my walking disclaimer here.

I think to—to some extent, the Saudis already feel a bit slighted by U.S. policy in the Middle East over the last ten years. So I don't know that that would be a new feeling or a new idea if there were a—a settlement—settlement at the P5+1 meetings.

I think, to take it to a more technical place, I think one question we would ask is that if sanctions were to magically go away tomorrow—and there's a lot of gray area in terms of what exactly a settlement would look like. But let's say hypothetically, all the sanctions were to go away tomorrow—how quickly could Iran bring production back to market? And similar to a Venezuela, for example, we think it would take a good, long while and a lot of investment to—to really put that production back on track.

So, you know, I think that they're—I've seen some—some headlines out there saying if sanctions go away tomorrow, if there's a settlement at these meetings, we'll have an extra three million-barrels a day on the market next month. And I think we need to be a little bit cautious about what that outcome would look like plausibly for the markets.
MORSE: And I'd just like to comment on the political relationship. I think one ought not to underestimate the Saudi need for open seaways, security. One ought not to underestimate the degree of positive cooperation between the countries on what we can call "homeland security issues" and the tightness of the relationship between people in the Saudi government and people in Washington, institutionally, based on that commonality of interest.

So I don't think whatever the P5+1 agreement may be or may not be with Iran, that that underlying set of common interests is going to be impacted significantly.

LIU: Alright, question? Yes. Gentleman. And again, could you identify yourself.

QUESTION: Stephen Blank.

At a moment when U.S. imports of crude have diminished dramatically, U.S. imports of Canadian crude have increased dramatically. In October, Canadian crude imports were almost two-thirds of that of Saudi Arabia. What's the story here? Why are we importing so much Canadian crude at this moment?

SPECTOR: Well, I work for a Canadian bank. I guess I can start that one.

Part of that is sort of baked in the cake. And in the mid-continent, this has been a long-developing situation where refineries in the mid-continent of the U.S. have specifically retooled to take Canadian crude. And then infrastructure developments, even absent Keystone XL, have now have made it possible to move Canadian crude beyond the mid-continent and into some other areas, as well.

So I think it's a combination of the relationship that refiners in the mid-continent have with Canada, and that's been an ongoing story, and then the newer development of added infrastructure to move those barrels south.

One thing I would point out though is that U.S. crude exports to Canada have also gone up significantly from close to zero a year or two ago to now 450,000 barrels a day. So if you look at the net, that's now a big enough number that we really have to take that into consideration. So those 450,000 barrels a day are a combination of Bakken and Eagle Ford barrels, the light sweet barrels feeding the Eastern Canadian refineries. And backing out—not Canadian barrels actually, really, but imported light sweet barrels. So other Atlantic Basin light sweet crude barrels.

QUESTION (OFF-MIKE): If XL comes online, would most of that oil, as someone said, be exported (inaudible) or would that fit into the U.S. market?

LIU: Just for our—I have to moderate this for—I have to make sure I'm brokering everybody. In D.C., if you didn't hear, his follow-up question was if Keystone does get built, will most of that crude be exported from the U.S?

SPECTOR: I think that that depends on the—the longterm relationships that the sellers of that crude established with buyers. So, you know, I think that the market maybe overestimates how nimble refiners are about shifting their slate around. Most of their crude is bought on the basis of a longterm relationship, and they're not necessarily going to switch from one month to the next.

So I think what is—what is yet to be seen is as more Canadian barrels make their way down to the Gulf one way or the other, my expectation is that some of those Canadian producers will establish those types of longterm relationships with U.S. refiners in the Gulf who still do need an imported, heavier barrel from someone.

But, you know, there's also the possibly that the economics of a longterm contract works, and some of it could also go other seas. You know, hypothetically, there's still plenty of imported heavy crude into the U.S. Gulf on a waterborne basis that could in theory be backed out, particularly since—you know, there are two countries that have increased their share of U.S. imports, which have, of course, gone down overall. But two countries that have increased their relative share of those imports over the last number of years, and that's Canada and Saudi Arabia. So Venezuela's been going down anyway and may continue to go down and make room for some of those Canadian barrels.
MORSE: Yes, I'd like to just add a couple of things, Steve. One—actually, they're both political.

But the first one is that if there were a country who—that is more dysfunctional when it comes to making energy policy than the U.S., it's Canada. And—

SPECTOR: See, that's the kind of thing I can't say. 
MORSE: And the reason we're importing as much crude is because the Canadian government can't find a way to move crude produced in Alberta into the only growing market in the world in the Pacific Basin. So if the Canadian political system could solve that problem, it wouldn't be exported to the U.S.

The second element is also a function of dysfunctional politics. And that is to the degree that it is remunerative to re-export Canadian crude out of the U.S., obviously, it depends on the (inaudible) across the seas for doing that. But to the degree that the U.S. lifts its irrational controls on exports, the U.S. light crude could be blended into Canadian Dilbit or other heavier Canadian crudes and be more marketable abroad.

So again, it's another political issue which needs to be resolved to overcome that obstacle.

LIU: Does anyone see that export ban disappearing at all?

Yes. And then I'll get one from the back.

QUESTION: David Goldwyn, Goldwyn Global Strategies.

I wanted to ask Ed and Katherine—I'd love to ask—talk about the crude oil export. But I want to come back to this question about the possibly of a production cut.

And thinking back to 1998 when EIA was projecting oil was at $10 dollars and projecting it would be so for the next five years; and then Saudi Arabia, Venezuela, and Mexico, in the need for revenue, agreed on a significant production cut, which no one saw coming, and brought those prices to $10 and $20 and $25, and then those of us in the administration all got kicked out.

So I think now, looking at the possibly that Saudi Arabia is more worried about Iran's return to the market, Iraq's claims of trying to go northward of at least five million or six million barrels a day; them being the head-to-head competitors in Asia, maybe they are trying to inflict pain on them.

But my question is, so what would it take for Saudi Arabia to contribute to a production cut. If Iran, Iraq, and Venezuela came up with a million barrels a day cut? Would they do 500,000 barrels a day? If this is about inflicting pain on them, when do they—when do they cave? When do they cry uncle and come up and say we're willing to kick in in a way that they haven't so far?
MORSE: Yes, I—I think, David, that they will look very closely at U.S. production levels. And I think the signal for a cut would be if damage done by lower prices puts U.S. production growth into negative territory. I think they don't want to be perceived as the guys who killed U.S. production, given the other overriding elements of it.

So I wouldn't look to anything done voluntarily or otherwise by Venezuela, Iran, Iraq, or other members of OPEC. Because I think they would not likely be credible. And I think that's not the main, you know, issue driving the kingdom's policy at the moment.

SPECTOR: I think a more likely scenario is probably involuntary production cuts from some of the OPEC members that they then might take credit for, I guess, in retrospect. But I'm not sure I see a credible decision taken to—to reduce production from its otherwise natural levels.

And I'm not sure—I'm not sure the Saudis will need to cut production. You know, I can paint a picture where as early as the second half of the year, if we were to have—let's say Libya goes back to zero, we have a force majeure in Nigeria, we lose a couple hundred thousand barrels a day of the U.S. growth, we lose a couple hundred thousand barrels a day in the FSU. You can paint a picture that may or may not happen, depending on how the stars align, where you actually get to a pretty supply reduction pretty quickly, and certainly enough to—to balance the market. So I'm not sure it will be necessary.

LIU: Howard, do you want to chime in on this?

GRUENSPECHT: Yes. Certainly, the scenario that Katherine reaches about an unintended production cuts, you know, is pretty significant. You know, contribute to price. Obviously, there's always the risk of social unrest in some of these countries. You know, on the—on the—you know, the demand picture could be somewhat stronger.

Again, when I look at the different demand outlooks, they differ by as much as 700,000 barrels a day in their growth for 2015 over 2014. You know, if you were looking at the higher-end scenarios there, that's a very, very significant change in the balance. I mean, we're talking about—you know, as Ed said, whether it's 900,000 barrels a day or a million barrels a day, this is in the ninety-million-barrel market. You know, we're talking about the margin. And very small changes on the margin can make a very big difference, you know, in the balance.

And again, the market's always looking forward. So if it looks like things are tighter than they think going forward and getting closer to balance, I think that gets reflected in—in markets fairly quickly.
SPECTOR: Howard, we've also had some pretty big revisions lately in the EIA's oil demand data for the U.S. So that's also something I've been struggling with a little bit in my balance.

GRUENSPECHT: Ooh, a struggle.
SPECTOR: Just saying.

GRUENSPECHT: Well—you know, it is really interesting about oil—

SPECTOR: But to your point about how the demand numbers can change quite—quite quickly—


GRUENSPECHT: Demand numbers can change. And actually, it's interesting. Because we—you know, I think we're the only country in the world that tries to do weekly—weekly balances. But a very big part of our demand numbers have to do with—you know, one of the things I think both Katherine and Ed have mentioned is that the export dimension on the product side, you know, has become a very important part of the overall picture in the U.S. market.

And unlike the import data, the refinery utilization data, the stocks data—which is really weekly data—effectively, the export data we have is two months old. And that is a significant weakness. It's one we're trying to address, actually. You know, we have to find ways to get that information in a more timely way. Obviously, don't want to burden the industry with it. You know, we're trying to work with some of our other federal agencies to help get that information on a more contemporaneous basis. And—

LIU: Howard—

GRUENSPECHT:—you know, that is, I think, one of the answers.

LIU: Howard, before I wrap it up here in New York, is there anybody in D.C. who has one more question?

GRUENSPECHT: Yes. I think there was—oh, a gentleman over here. Yes.

QUESTION: Chris Wall.

And actually, to pick up on point, as well as a comment that Betty made earlier, the crude oil export ban. How do you see the economics globally playing out in this context, as well as domestically with the crude oil—with the refinery composition, the—with the light sweet crude that we're producing and whether we have the ability to absorb that and then other factors of that sort. And finally, how does that play into the policies of the ban?
GRUENSPECHT: Well, I won't speak to the politics of anything. But, you know, there are interesting economic questions surrounding that. I mean, one—one has the notion that—there's already been discussion of the refinery configurations and the like. You know, it's also—sometimes it's—it's perceived that it's like it's impossible for any further investments to be made in the United States, you know, facing this uncertainty.

I think prices do matter in this regard. I think for the right prices, you know, you would find domestic investment and processing capability. Probably U.S. demand is not going to be, you know, very sensitive to anything that happens in this area. So if—if U.S. crude oil production's going to rise, you know, and—the—wouldn't call it the export ban, because it isn't a ban. There was already discussion, I believe, that exports might be at their highest historical level ever. So it's kind of hard that we can be talking about an export ban at a time when exports are at their highest historical level.

But to take your point, you know, right now you can export product. So I guess one possibility is that the United States has already turned into a great merchant refining center. And in a world where the export current limitations persist, you might find the U.S. becoming an even bigger merchant refining center. You know, in a world where the limitations change, you might find less of that and more exports of—of crude oil.

But—now, there may be some difference in the level of production in those two scenarios because of the pricing of that domestic crude oil it might take to incentivize the addition of capacity to process it domestically and then export the products.

So it's a real interesting—you know, I think everyone understands how—qualitatively, how everything is connected. I guess the question is quantitatively, how does it work out? And, you know, there've been a lot of studies done and EIA is doing some work in that area.

And I think my colleagues might want to say something about that.

LIU: One last comment? And you put your hand up before.


LIU: OK. I'm going to have to wrap up here. But before I go, a quick, simple question for all three of you.

Are we ever going to get back to $100 oil? Ed?

MORSE: Not in this decade in all likelihood.

SPECTOR: Ever—absolutely. And yes, I think in this decade we'll see $100.

LIU: In this decade?


LIU: OK. Howard?

GRUENSPECHT: Well, I still have my bell bottom trousers from the Carter Administration in my closet. So yes. I would think ever, yes. Ever, yes.

MORSE: Do you—do you fit in them, Howard?

GRUENSPECHT: Ed, you're too...that was the best I have heard. 


Good one. I owe you.

LIU: On that note, thank you so much to the Council on Foreign Relations and to Ed, Katherine and Howard for joining me. Thank you.

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