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Valuation Assumptions
Economic Advisors, Inc., Denver 2
● our analyses must include a broad range of considerations
sector...
Oil – recent history
Crude Oil Prices
US EIA, data updated September 2, 2016
Economic Advisors, Inc., Denver 3
$/bbl
Oil – recent history
Crude Oil Prices
US EIA, data updated February 2, 2016
Economic Advisors, Inc., Denver 4
$/bbl
China
...
Agenda:
Economic Advisors, Inc., Denver 5
Political risks in the market for crude oil
Commercial / economic factors driv...
Oil – new conventional wisdom
Economic Advisors, Inc., Denver 6
The OPEC era is past; they’ve lost control of the market....
Conclusion (preview - … the short story):
Economic Advisors, Inc., Denver 7
OPEC = Saudi Arabia => dominant firm = price ...
Agenda:
Economic Advisors, Inc., Denver 8
Is OPEC a cartel?
Economic Advisors, Inc., Denver 9
D: cartel = an association of suppliers who coordinate to
maintain hi...
OPEC is Saudi Arabia
Economic Advisors, Inc., Denver 10
How often do OPEC Member States exceed production quotas?
A: all...
Price Leader price setting
Economic Advisors, Inc., Denver 11
Saudi Arabia is
 price leader
 dominant firm
 monopolist...
Price Leader price setting
Economic Advisors, Inc., Denver 12
What has changed for Saudi Arabia (the price leader)
A: on ...
Price Leader price setting
Economic Advisors, Inc., Denver 13
What has changed for Saudi Arabia (the price leader)?
A: Ch...
quantity
price
Economic Advisors, Inc., Denver 14
Price Leader price setting
S=MC
D
P
Q
MC
MR
Recall monopoly pricing:
mo...
quantity
price
Economic Advisors, Inc., Denver 15
Price Leader price setting
S=MC
D
Q
MC
MR
Notice P-MC markup is lower w...
Price Leader price setting
Economic Advisors, Inc., Denver 16
Saudi Arabia is
 price leader
 dominant firm
 monopolist...
Price Leader price setting
Economic Advisors, Inc., Denver 17
Saudi Arabia is
 price leader
 dominant firm
 monopolist...
production
($)
fixed
costs
total
costs
cost structure of traditional basins
= high ratio of fixed costs to
variable costs:...
Price Leader price setting
Economic Advisors, Inc., Denver 19
Saudi Arabia = monopolist with competitive fringe
 Supply ...
Saudi Arabia price setting
Economic Advisors, Inc., Denver 20
Economic / commercial considerations can justify prices as
...
Agenda:
Economic Advisors, Inc., Denver 21
Gulf States divide
Sunni vs Shia
Ahl al-Sunnah = ‘People of
theTradition’
632 AD – followers of Abu
Bakr, friend and fat...
Gulf States divide
Sunni vs Shia
Economic Advisors, Inc., Denver 23
Shiat Ali = ‘the party of Ali’
632 AD – followers of...
Gulf States divide
Sunni vs Shia
Economic Advisors, Inc., Denver 24
Ahl al-Sunnah = ‘People of
theTradition’
632 AD – fo...
Stakeholders in Market for Oil
Economic Advisors, Inc., Denver 25
domestic poli/econ interests geo-political interests
Rus...
Stakeholders in Market for Oil
Economic Advisors, Inc., Denver 26
domestic poli/econ interests geo-political interests
Rus...
quantity
price
Economic Advisors, Inc., Denver 27
Geopolitical impact on pricing
Secon&politics
D
P= $60 to $80
Q
MC
MR
P=...
Looking forward - oil:
Economic Advisors, Inc., Denver 28
Looking forward - oil:
Economic Advisors, Inc., Denver 29
A: they wouldn’t.
A: they wouldn’t.
A: less critical per capital...
Looking forward - oil:
Economic Advisors, Inc., Denver 30
Outlook:
Economic Advisors, Inc., Denver 31
Oil:
 OPEC will curtail production to raise prices as they confirm
Iran is ...
Questions?
Economic Advisors, Inc., Denver 32
EA-MJOrlando - NAPE Denver slides - 1610
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EA-MJOrlando - NAPE Denver slides - 1610

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Presentation to NAPE Denver Expo, October 2016, on OPEC pricing strategy and political risks.

Published in: Economy & Finance
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EA-MJOrlando - NAPE Denver slides - 1610

  1. 1. Valuation Assumptions Economic Advisors, Inc., Denver 2 ● our analyses must include a broad range of considerations sector - wide (macro) project - specific (micro) - economic considerations - technological considerations - commercial considerations <--------------- political considerations ---------->
  2. 2. Oil – recent history Crude Oil Prices US EIA, data updated September 2, 2016 Economic Advisors, Inc., Denver 3 $/bbl
  3. 3. Oil – recent history Crude Oil Prices US EIA, data updated February 2, 2016 Economic 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?
  4. 4. Agenda: Economic Advisors, Inc., Denver 5 Political risks in the market for crude oil Commercial / economic factors driving crude oil markets
  5. 5. Oil – new conventional wisdom Economic Advisors, Inc., Denver 6 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.
  6. 6. Conclusion (preview - … the short story): Economic Advisors, Inc., Denver 7 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?
  7. 7. Agenda: Economic Advisors, Inc., Denver 8
  8. 8. Is OPEC a cartel? Economic Advisors, Inc., Denver 9 D: cartel = an association of suppliers who coordinate to maintain high prices and restrict competition plural notice competing objectives here and here
  9. 9. OPEC is Saudi Arabia Economic Advisors, Inc., Denver 10 How often do OPEC Member States exceed production quotas? A: all the time Who has enough spare capacity to control prices? A: Source: Medium-Term Oil Market Report 2014, OECD/IEA
  10. 10. Price Leader price setting Economic Advisors, Inc., Denver 11 Saudi Arabia is  price leader  dominant firm  monopolist with competitive fringe
  11. 11. Price Leader price setting Economic Advisors, Inc., Denver 12 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)
  12. 12. Price Leader price setting Economic Advisors, Inc., Denver 13 What has changed for Saudi Arabia (the price leader)? A: China deceleration => optimal price  What risks were present at +$100/bbl oil?  will China industrialize as a oil-intensive economy?  Will China consumer demand for energy be highly oil- dependent? Or highly diversified?  Strategic opportunity to influence path of development? => optimal price 
  13. 13. quantity price Economic Advisors, Inc., Denver 14 Price Leader price setting S=MC D P Q MC MR Recall monopoly pricing: moderation in China demand growth
  14. 14. quantity price Economic Advisors, Inc., Denver 15 Price Leader price setting S=MC D Q MC MR Notice P-MC markup is lower with more elastic demand P more diversified demand can increase elasticity
  15. 15. Price Leader price setting Economic Advisors, Inc., Denver 16 Saudi Arabia is  price leader  dominant firm  monopolist with competitive fringe China => P for current slowdown & to encourage oil- intensive industrialization Elsewhere  EM softness (x – India) => P  Developed economies softness and drop in energy intensity => P
  16. 16. Price Leader price setting Economic Advisors, Inc., Denver 17 Saudi Arabia is  price leader  dominant firm  monopolist with competitive fringe What about the supply side?  traditional competitive fringe = conventional development (read large-fixed cost development prospects)  new competitive fringe = shale oil
  17. 17. production ($) 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 Economic Advisors, Inc., Denver 18 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
  18. 18. Price Leader price setting Economic Advisors, Inc., Denver 19 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 weakness P 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
  19. 19. Saudi Arabia price setting Economic Advisors, Inc., Denver 20 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/day What 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?
  20. 20. Agenda: Economic Advisors, Inc., Denver 21
  21. 21. Gulf States divide Sunni vs Shia Ahl al-Sunnah = ‘People of theTradition’ 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) Economic Advisors, Inc., Denver 22
  22. 22. Gulf States divide Sunni vs Shia Economic Advisors, Inc., Denver 23 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, Lebanon consider ayatollahs as agents of spiritual precepts
  23. 23. Gulf States divide Sunni vs Shia Economic Advisors, Inc., Denver 24 Ahl al-Sunnah = ‘People of theTradition’ 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, Lebanon consider ayatollahs as agents of spiritual precepts
  24. 24. Stakeholders in Market for Oil Economic Advisors, Inc., Denver 25 domestic poli/econ interests geo-political interests Russia (producer / price taker) Iran (producer / price taker) China (consumer / price taker US (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?
  25. 25. Stakeholders in Market for Oil Economic Advisors, Inc., Denver 26 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
  26. 26. quantity price Economic Advisors, Inc., Denver 27 Geopolitical impact on pricing Secon&politics D P= $60 to $80 Q MC MR P= $40 Q Russia Iran US Saudi Arabia China
  27. 27. Looking forward - oil: Economic Advisors, Inc., Denver 28
  28. 28. Looking forward - oil: Economic Advisors, Inc., Denver 29 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.
  29. 29. Looking forward - oil: Economic Advisors, Inc., Denver 30
  30. 30. Outlook: Economic Advisors, Inc., Denver 31 Oil:  OPEC will curtail production to raise prices as they confirm Iran is a manageable risk Large, 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
  31. 31. Questions? Economic Advisors, Inc., Denver 32

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