Outlook for oil prices and North Sea production

Oil prices remain volatile and stubbornly above $100 a barrel. We talked to Sam Wahab, energy analyst at Peel Hunt, about what’s going on, the outlook for energy prices and the future of oil & gas production in the North Sea.

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Lee Wild, head of equity strategy at interactive investor: Hello. With me today I have Sam Wahab, energy analyst at Peel Hunt, to talk about the energy sector and what the future might hold.

Ongoing volatility in the Middle East means oil prices remain significantly higher than the $70 a barrel we saw briefly during the summer. Could you please just bring us up to speed on the current situation?

Sam Wahab, energy analyst at Peel Hunt: Yeah, absolutely.

Clearly it has been a volatile period, and pre that $70 that you mentioned, that was really off the back of what is, and what we know now, to be a very fragile Memorandum of Understanding (MOU) between the US and Iran. But since then, diplomatic efforts have sort of failed to bring a resolution to the situation, so we have seen that track back up.

Continued attacks have pushed the oil price further. And what I would say about that is that the geographical risk premium being applied to the oil price is quite significant. So, those vessels going through the Strait of Hormuz are being attacked all the time. There has been intimations of mine incidents. We only saw last week an Indian vessel with two million barrels of crude oil being attacked.

And so, what we’re seeing is that insurance companies are applying a real risk premium to each vessel that goes through. Now, that’s being fed through to the consumer of those barrels. So, a higher oil price or a structurally higher oil price is here to stay, at least for the medium term, because that’s being passed on. And so where do we move on from here?

We saw yesterday, and overnight, that there were additional Houthi attacks on Saudi Arabia. So, that’s why when I left the office to come to our meeting, the price on screen was $112. So, it’s moving it exponentially.

What does that mean across the world? We’re seeing it increasingly fragmented. So, the likes of Europe and East Asia, they are paying anywhere between $120 and $160 a barrel. The US are the likely winners at the moment, and parts of North America, they are paying WTI prices sub $100. Obviously, it’s hurting everyone globally, but there is that sort of dichotomy across the market, so it is an increasingly worrying problem.

Lee Wild: Yeah. We hear reports that, probably out of the US, that passage through the Strait of Hormuz is returning to sort of pre-war levels. There are lots of doubts about that claim. What do you think is going to happen to the oil price in the coming months? Are you hearing those reports as well, and how do you think what is a very messy situation will get resolved?

Sam Wahab: Well, it’s interesting, and it’s a very good question because, yes, we do hear those reports, and even during the heightened impact of the war, we were hearing that there were dark fleets going through into China, basically. 

But as I say, they are going at increased premiums because insurance companies just simply won’t insure those vessels at the rates that they used to do, and people won’t take those risks. We’re talking about listed companies behind the insurance companies and the people that fulfill those voyages. 

We have seen increasingly recently - we’ll probably come on to the midterms that are coming up - that there are diplomatic efforts, particularly from Qatar and Pakistan, to go in and try and see a resolution as soon as possible because all of their economies are hurting. On a domestic level, there could potentially be uprising. We’ve seen stuff going on in France, etcetera.

In terms of where I see it, I think the Iranians are not an easy push on this. They are willing to hold out. They have done for 47 years, right, in terms of Western intervention into their geopolitics?

I think as well, who are they negotiating with? So, they are intentionally fragmented. So, you’ve got the ayatollah, you’ve got the president, you’ve got the IRGC [Islamic Revolutionary Guard Corps]. Which one of those really holds the cards in these conversations? So I think that adds another layer of difficulty from the US, from Israel, in trying to get a resolution to this.

And let’s not forget the damage that’s been done. OK, so I mentioned the Saudi Arabians and their domestic infrastructure, the airport being targeted. But so much of their LNG infrastructure has also been hit, and that has massive implications, particularly for Europe, because that’s where most of it goes to from Qatar.

So, I think this could play out for a long time, but the one thing I would say is oil is not going back to the $65 that we saw at the start of the year because of the structural problems that have already taken place and what might come. And we’re seeing that play out on screen increasingly so. 

And, not to try and get too technical about it, but as analysts, we look at things like backwardation, which is where the futures contracts trade relative to the price you see on screen. Now, that was quite deeply backwardated, which means it was coming down from $110 to, say, $65. 

We’re seeing that increasingly going up, and that’s a real problem in terms of where we buy our oil in the future and in terms of the cost of living in the West. So, at this stage, we’re looking higher for longer.

Lee Wild: To be clear, backwardation, you’re referencing options markets. You are looking a number of months into the future?

Sam Wahab: Yeah, it could be six months ahead.

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Lee Wild: And do you think, I mean, it’s an impossible question, but do you think a resolution is a 2027 thing, or could this really rumble on, like we’ve seen in Ukraine?

Sam Wahab: Yeah, it could do. If you look at, and this is on a much smaller scale, what happened in 2003 in the invasion of Iraq and Afghanistan, obviously there wasn’t a choke point there in terms of oil, but it did disrupt the oil market at the time. This is much worse, I would say.

I think there is more appetite from…what the US call the aggressor in terms of pushing this further on. We’ve got the midterms on 3 November. I think they’re willing to see whether Trump loses the House and the Senate. I think that’s a real possibility at the moment. His poll ratings are at all-time lows. So, they see this. They’ve got TVs. They understand this as well. S,o that’s a real possibility that we’re going to move at least past November.

Then we’ve got to look at: what does a resolution look like? The Iranians know they’ve got real traction here from a global perspective, so they’ve got real leverage against the whole West, not just Israel and the US. So, what would that mean?

Could that mean unfreezing of assets? I think that’s a given. Could that mean lifting sanctions? I think they would want that. They’d want to come back into the international community. And then finally, which is, I think, the sticking point between the two sides, [is] whether they can charge a toll for each vessel coming through the Strait of Hormuz.

I think from their eyes, they say, ‘Look at the damage that’s been done to the country. We need to be recompensed, repaid for all of this.’ And I think that’s where the issues the two sides are having. Obviously, [there’s] the nuclear issue, but I think that had already been resolved through the Obama administration, so it’d just be sort of progressing that further.

So, we’ll see what happens. I personally think that there will be a toll. I think the first two options will happen. There will be a toll. Trump will sell it as something else, just an additional tax. It won’t be called a toll, but they will want to be repaid. They see the leverage that they have.

Lee Wild: So, look, high oil prices, that’s raised the focus on energy security. It’s become a major theme over the past few years, especially since the Iran conflict. 

So, we’ve just heard about government approval for extraction from the Jackdaw gas field in the North Sea, and there are other undeveloped UK assets in the North Sea. Should we be exploiting assets there more than we are? Is there a good reason for the slow progress, or is it really the answer to domestic energy supply?

Sam Wahab: Yeah, I think we should be. I think it’s foolhardy not to exploit domestic barrels if you do have them. We’re in a fortunate position as a country to have them on their doorstep.

I think personally, it’s fairly farcical to think that emissions will come down by importing it through another source, an overseas source, especially LNG, which is highly diesel dependent. Our three primary sources of LNG are: one, Qatar, two, Norway, three, the US, right? So, there is transportation in there.

The UK has probably one of the highest standards of regulations in the world in terms of extraction, and so it’s much lower emissions to produce from our own doorstep. That’s just one.

Second is that, yes, of course, it’s not going to move the needle in terms of the wholesale price of energy, the oil that we see on screen, the nat gas prices that we see on screen. 

But what it does do, it increases the tax receipts to the public purse. So, on a corporation level, you can tax the companies. Already in this country with the energy profits levy, we’re seeing bottom line of 78% for those that don’t have tax losses. And so you’re going to see an increase in tax receipts and the lowering of domestic consumption of emissions.

Then you look at job security. This will employ thousands of people, not just in Aberdeen, but all across the country and from overseas. And so you’ve got the income tax and national insurance receipts. So, it’s almost a no-brainer. It feels like more of an ideology and a vote winner than it does in terms of real economic sense. So, I do think it makes more sense to exploit what’s on your doorstep.

Now, you mentioned Jackdaw. It was a positive, I think, that they approved that yesterday. What happens with Rosebank, we don’t know. Jackdaw is very much a gas field. Rosebank is 90% oil, and so that will see a political issue in itself to try and sell that to backbenchers and, indeed, the public. I think the public are pretty much OK with it given the cost-of-living pressures that we see within the country. So, we wait and see, but it does feel like the pendulum is swinging back from ideology to pragmatism.

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Lee Wild: Yeah. Well, high energy prices are clearly a problem for the consumer as well, and there are implications for the so-called energy transition. So, with consumers looking at significant increases to household bills this year and next, is it more a case of having the cheapest energy as opposed to the cleanest energy?

Sam Wahab: I think so. But I think there is also a misconception in terms of what cleaner energy entails and the cost-effectiveness of it.

At the moment, we are in a cost-of-living crisis. We see our bills rising exponentially. The UK and Ireland are only behind Bermuda in the world in terms of the highest energy prices, which I think is significant when we’ve already discussed what is on our doorstep and what Norway are experiencing, who are also pushing into the energy transition. 

I think there needs to be a managed transition because renewables are the future. But I do think there are a number of steps the government could potentially take to reduce energy bills for consumers, and I know Andy Burnham has taken steps to reduce the VAT element, which obviously has just been eaten up by the global pricing benchmarks. 

But the green levies temporarily, I think, could be removed from energy bills. And I’m not saying forever, because I do think investment in renewables is important. But then also the decoupling of electricity to gas, because at the moment, we’re paying electricity on the same basis at not just any gas price, the NBP that you see on screen, but it has to be the highest at any moment in time, which I think is just bonkers, really, for the consumer to have to pay that and the deal that they are in.

So, in terms of where we go from here, I think you’re right. We do need to get cheaper energy sources in. At the moment, the issue that we have with renewables within this country is that the deployment of wind and solar has not kept pace with grid connectivity. 

We have very limited storage capabilities within the country as well. So, what we’ve done is pay in operators to build wind and solar farms, but ourselves, we have not invested the money to keep the grid up to pace with it, which is why when the wind doesn’t blow, or indeed if it blows too much, we’re actually paying the operator for that balancing, to either switch it off or not operate at all. I don’t think there are many countries in the world that do operate under that system.

So, there’s many steps that we can take to help the consumer. And, as I say, the green levy issue I think should only be temporary because I am all for renewables in the future, but it has to be that managed transition.

Lee Wild: Great. Sam Wahab, energy analyst at Peel Hunt, thanks very much for joining me today.

Sam Wahab: Thanks very much.