When developing a strategy or making investment decisions, there will be many uncertainties that need assessment. These can range from cost and timing issues to broader questions at the macro level, for example political, regulatory or social developments. A way to get to grips with the latter category is by using ‘scenario analysis’, sometimes called ‘scenario thinking’ or ‘scenario planning’.
A scenario in this context is an alternative future: a coherent narrative of a set of developments, trends and events that could unfold within some defined environment space. Examples of such spaces are: a country, a group of countries, a sector, a city, the world. This is the environment space within which an entity (company, organization) anticipates operating over a predefined time frame, usually somewhere between 10 and 40 years. By articulating multiple such scenarios, each internally consistent but distinctly different, the entity is able to fathom various significant external (contextual) uncertainties that might have an impact on its future well-being or existence.
The purposes of scenarios can be multiple. They are a framework for discussion and strategy development. The entity can use them to engage with external parties. They can be a means to bridge gaps between different interests. A famous example of that are the Mont Fleur scenarios in South Africa, composed in 1991. In this article I however focus on the use of scenarios for decisions.
The question is how, once the scenarios are available and digested, the entity can use these in decision making. The common basis for investment or strategic decisions is some quantification of opportunity attractiveness coupled to various forms of risk analysis. Descriptions of alternative futures, however interesting they may be, do not easily find a place within the decision processes. For example, in most cases it is not (credibly) possible to assign probabilities to scenarios to sharpen the outlook (in another article I will discuss situations when this may nevertheless be an option). There is not a most likely future that can be used as a basis for landing the decision. The fuzziness around the scenario concept makes it difficult to appreciate its use for concrete decisions. This is the reason for the skepticism that the scenario approach encounters in many organizations. It should, however, be accepted that scenario analysis, like any quantitative modelling for that matter, does not eliminate the uncertainties. It justs helps to map them out, frame them, categorize them, discuss them. But we will see that meaningful operationalization of scenarios is certainly possible.
I distinguish three ways of incorporating scenario analysis in the decision making process.
Firstly there is the pervasive impact of the influence on senior leaders and decision makers within the organization of the insights that are brought about by the scenario analysis process. When a significant decision is taken, the underpinning data and analysis, of course, play a crucial role. However, the experience, background and intuition of decision makers is also important. In decision boards they will bring their own perceptions and judgements to the table, calibrating these against the analysis results and information presented to them. The insights from scenarios will assist shaping the perceptions of decision makers of the future contextual environment. At that level, they will have clear views of their own about themes such as the market, (geo)politics, technology and societal developments. Scenarios will enrich these perspectives and allow decision makers to adapt and adjust their thinking as appropriate. A well known characterization is that scenarios act like ‘memories of the future’. Of course it is then a great benefit if senior leaders within an organization are involved themselves in devising the scenarios to the extent practical.
Secondly there is the option of qualitatively stress testing investment decisions, but in particular strategies, against the different scenarios developed. This is what Kees van der Heijden, in his book Scenarios, The art of strategic conversation, called ‘wind tunneling’. This is about creating a matrix with the scenarios on one axis and the various strategy options on the other axis. Each box triggers a discussion of how attractive a specific strategy option will be under a particular scenario. This could result in qualitative attractiveness scoring in some form. Also here, the discussion associated with this process is more important than the resulting overview.
Thirdly, a quantitative approach is possible. The starting point is the key decision variable, for example the (aggregate) NPV of the investment or strategy. This variable is decomposed in its components (revenues, costs, tax) and the chain of influences on these components is mapped out. This is best done with an influence diagram so as to also visualize the interrelationships. In the contexts of the various scenarios, reasonings and quantitative assumptions are developed for the key influences. This is worked through to the level of the NPV: different NPVs under different scenarios (even better: NPV ranges under different scenarios). For the quantitative analysis techniques from the econometrics discipline can be useful (e.g. regressions). Sometimes a system dynamics model can be of assistance. But it does not need to be very complicated. Developing rounded estimates of some key external drivers whilst considering the interrelationships can be good enough. This is in fact what oil companies do (to some extent) when they annually consider a scenario based outlook for the oil price, link this to an assumption about cost escalation, exchange rates and a future price for carbon emissions.
There is no scheme that will allow collapsing all considerations into one number of attractiveness of an investment opportunity or strategy for the benefit of decision makers (except perhaps by judgementally assigning a ‘score’). But the earth is not flat and projecting its surface on a plane leads to substantial geometric distortions. Likewise, the richness of a scenario based analysis should not be kept away from decision makers, be it that the insights need to be adequately presented. Vice versa, decision makers should be prepared to digest the perspectives offered by the scenario approach and contrast that with their own perceptions, even though in the end the decision itself may be quantifiable by a single bit: 0 or 1.
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The Permian is in desperate need of pipelines. That much is true. There is so much shale liquids sloshing underneath the Permian formation in Texas and New Mexico, that even though it has already upended global crude market and turned the USA into the world’s largest crude producer, there is still so much of it trapped inland, unable to make the 800km journey to the Gulf Coast that would take them to the big wider world.
The stakes are high. Even though the US is poised to reach some 12 mmb/d of crude oil production next year – more than half of that coming from shale oil formations – it could be producing a lot more. This has already caused the Brent-WTI spread to widen to a constant US$10/b since mid-2018 – when the Permian’s pipeline bottlenecks first became critical – from an average of US$4/b prior to that. It is even more dramatic in the Permian itself, where crude is selling at a US$10-16/b discount to Houston WTI, with trends pointing to the spread going as wide as US$20/b soon. Estimates suggest that a record 3,722 wells were drilled in the Permian this year but never opened because the oil could not be brought to market. This is part of the reason why the US active rig count hasn’t increased as much as would have been expected when crude prices were trending towards US$80/b – there’s no point in drilling if you can’t sell.
Assistance is on the way. Between now and 2020, estimates suggest that some 2.6 mmb/d of pipeline capacity across several projects will come onstream, with an additional 1 mmb/d in the planning stages. Add this to the existing 3.1 mmb/d of takeaway capacity (and 300,000 b/d of local refining) and Permian shale oil output currently dammed away by a wall of fixed capacity could double in size when freed to make it to market.
And more pipelines keep getting announced. In the last two weeks, Jupiter Energy Group announced a 90-day open season seeking binding commitments for a planned 1 mmb/d, 1050km long Jupiter Pipeline – which could connect the Permian to all three of Texas’ deepwater ports, Houston, Corpus Christi and Brownsville. Plains All American is launching its 500,000 b/d Sunrise Pipeline, connecting the Permian to Cushing, Oklahoma. Wolf Midstream has also launched an open season, seeking interest for its 120,000 b/d Red Wolf Crude Connector branch, connecting to its existing terminal and infrastructure in Colorado City.
Current estimates suggest that Permian output numbered around 3.5 mmb/d in October. At maximum capacity, that’s still about 100,000 b/d of shale oil trapped inland. As planned pipelines come online over the next two years, that trickle could turn into a flood. Consider this. Even at the current maxing out of Permian infrastructure, the US is already on the cusp on 12 mmb/d crude production. By 2021, it could go as high as 15 mmb/d – crude prices, permitting, of course.
As recently reported in the WSJ; “For years, the companies behind the U.S. oil-and-gas boom, including Noble Energy Inc. and Whiting Petroleum Corp. have promised shareholders they have thousands of prospective wells they can drill profitably even at $40 a barrel. Some have even said they can generate returns on investment of 30%. But most shale drillers haven’t made much, if any, money at those prices. From 2012 to 2017, the 30 biggest shale producers lost more than $50 billion. Last year, when oil prices averaged about $50 a barrel, the group as a whole was barely in the black, with profits of about $1.7 billion, or roughly 1.3% of revenue, according to FactSet.”
The immense growth experienced in the Permian has consequences for the entire oil supply chain, from refining balances – shale oil is more suitable for lighter ends like gasoline, but the world is heading for a gasoline glut and is more interested in cracking gasoil for the IMO’s strict marine fuels sulphur levels coming up in 2020 – to geopolitics, by diminishing OPEC’s power and particularly Saudi Arabia’s role as a swing producer. For now, the walls keeping a Permian flood in are still standing. In two years, they won’t, with new pipeline infrastructure in place. And so the oil world has two years to prepare for the coming tsunami, but only if crude prices stay on course.
Recent Announced Permian Pipeline Projects
Headline crude prices for the week beginning 3 December 2018 – Brent: US$61/b; WTI: US$52/b
Headlines of the week
The engine oil market has grown up around 10 to 12% in the last three years because of various reasons, mostly because of the rise of automobiles.
According to the Bangladesh Road Transport Authority (BRTA), the number of registered petrol and diesel-powered vehicles is 3,663,189 units.
The number of automotive vehicles has increased by 2.5 times in the last eight years.
The demand for engine oils will rise keeping pace with the increasing automotive vehicles, with an expected 3% yearly growths.
Mostly, for this reason, the annual lubricant consumption raised over 14% growth for the last four years. Now its current demand is around 160 million tonnes.
The overall lubricants demand has increased also for the growth of the power sector, which has created a special market for industrial lubricants oil.
The lubricants oil market size for industries has doubled in the last five years due to the establishment of a number of power plants across the country.
The demand for industrial oil will continue to rise at least for the next 15 years, as the quick rental power plants need a huge quantity of lube oil to run.
The industries account for 30% of the total lubricant consumption; however, it is expected to take over 35% of the overall demand in the next 10 years.
Mobil is the market leader with 27% market share; however, market insiders say that around 70% market shares belong to various brands altogether, which is still undefined.
It is already flooded with many global and local brands.