Anand Gnanamoorthy's Blog


Hey Pump Manufacturers: Oil is in the $20’s! Are you still forecasting the same way you did last year?

20 Jan 2016 | by Anand Gnanamoorthy
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Last week, Flint Hills Resources LLC, the refining arm of billionaire brothers Charles and David Koch’s industrial empire, said in its website that it will pay $1.50 a barrel for North Dakota Sour, a high-sulfur grade of crude. Yes, you read it right. Instead of getting money for selling, they are paying money to take it out off their hands.

A producer willing to pay to take their oil away is certainly unheard of. So, why did that happen? Here is what we know:

  • Saudi Arabia, wanting to break the NA Shale producers, started pumping oil at full speed.
  • Oil dropped to below $40 in 2015 amid concerns of over production, slowing demand from China and Europe.
  • Even though oil has reached some of the lowest possible price levels, the market has not seen commensurate decline in production.
  • With economic sanctions lifted, Iran is ramping up its production to enter the market. Fearing the worst, oil prices crashed and WTI prices ended below $30.

 

Crude Oil Futures

 


What happens next is anyone’s guess. Here are some possible scenarios:

  • Oil heads back to $100 quickly
    • WTI price reaches below $20. This might lead to drastic reduction in oil production as smaller players are completely pushed out of the market causing temporary demand and supply mismatch. This might bring oil soaring back to $100. While smaller players will be unable to come back online in the short term, U.S. shale producers, Russia and OPEC producers will benefit from the opportunity. With upstream and downstream segments experiencing growth, there would not have been a better time for pump manufacturers focused in oil and gas.
    • Saudi Arabia might blink first. With war in Yemen, increasing subsidy and raising gap, Saudi Arabia might be forced to reduce output for a short time causing the prices to come back.
  • Oil stays below $30 for an extended period
    • As with the 1980s oil crisis, the prices might gradually decline and stay low for an extended period of time. Technology innovations and process improvements will aid in producers drilling oil efficiently and cost effectively. Everyone will be forced to fight for a smaller pie.
  • Oil gradually recovers to $70
    • The conventional wisdom in the market tells us the things will gradually get better and sometime in the future things will head back to being normal. Maybe in next 3 to 4 years, production will stabilize and price will find a new normal at $70.

Even though there are ample examples of volatility and unknown risks, companies still try to apply existing forecasting analysis to develop short term strategies.  Nassim Taleb, author of “The Black Swan: The Impact of the Highly Improbable”, has been tirelessly trying to point out the failure in our current forecasting analysis. He terms events like these as “Black Swan Events” that follow 3 major attributes:

  • Rarity – Till Aug 2014, everyone prophesied that oil price will stay above $100 for next five years.
  • Extreme impact – In 2016, for the first time in past 3 decades, end-users will cut CAPEX investment for a second straight year.
  • Retrospective predictability – Everyone now can easily explain why the prices crashed. Markets failed to factor in the increased oil production from shale and gradual decline in global consumption.

While most of the pump manufacturer forecast based on current assumption expecting “more of the same”, we have seen this is anything but. Many companies develop a pessimistic or optimistic scenario, but still do not consider impact of extreme events. For example, many companies were caught unaware by the 2009 recession. Pump market declined more than 20%. The pump manufacturers implemented drastic production cut and “right sizing” of their workforce. But the very next year, the pent-up demand boosted the pump market by more than 10%. Pump manufacturers were unable to take advantage of the bonanza.

If you are pump manufacturer and want key perspectives on the 2016 pump market growth and short term strategies, shoot a quick email to me and I will be happy to work with you. Also, watch out for Frost & Sullivan’s 2016 Pump Outlook, providing a valuable snapshot of the industry and in-depth analysis of the pump market plus important expectations for 2016. 

Comments:

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Posted by Poornima Vijayan | 11 Jun 2017

 
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