Adios to cheap oil in globalization

cheapoilby Gerardo Honty – By the end of 2015, the price of petroleum had fallen to values of the beginning of the century; after having reached a peak close to US$ 150 per barrel in 2008, the prognostics indicate that the prices will continue low in 2016, something that is difficult to explain in a world where it is ever more costly to produce petroleum. Nevertheless this situation paradoxically confirms the end of the era of cheap petroleum. It is worth an attempt to explain what is happening.

The crisis in conventional and unconventional petroleum

At the beginnings of this century the threat of a “peak” of petroleum (maximum possible world production) hovered over the analysis of the petroleum market. The obvious expected restriction in the offer of crude oil brought investors to put their resources into a new technology: “shale oil” and “tight oil” (petroleum from schist or compact formations). The expectation of high prices set off a “shale revolution” in the USA. The consequence was that, as from 2010, the production of petroleum in that country rose from 0.5 to 4.5 million barrels daily in 2014(1).

But the machine killed the inventor and the US offer flooded the market, which, together with the deceleration of the economy, provoked a drop in prices. The US oil companies began to cut down on expenses, sold assets, reduced the number of wells by over half, so the majority of companies managed to survive. Nevertheless, with prices below $50 per barrel, drilling companies such as Samson Resources and Magnum Hunter Resources declared bankruptcy and others may well follow them (such as Chesapeake, Southwestern Energy and Ultra Petroleum).

If the prices remain below $50 per barrel, the shale crisis in the United States could drag down banks and financial institutions that supported it, as has been noted by various analysts (2). But the crisis did not only affect the US oil companies: BP has announced the reduction of their work force by 15%, Pemex indicated that it would lay off 13,000 workers, Shell has sold off some of its assets, to cite a few examples.

OPEP, meanwhile, maintained its high volumes of production (with lower costs than their schist adversaries) in an attempt to destroy the US industry, according to some analysts. However, this strategy is dangerous since it affects the economies of the Arab countries and other petroleum States, to the point where the Saudi government is thinking of privatizing some sectors of the national oil company, Saudi Arabian Oil Co. (Saudi Aramco). This is the only Saudi oil producing company, owner of the second largest oil reserves in the world and controlling more than ten per cent of the world’s petroleum production.

In Saudi Arabia the deficit in 2015 reached 98 billion dollars (double the estimates) and domestic petroleum prices have risen by 40%. Similar measures had been taken in other countries such as the Arab Emirates and Venezuela. The Arab States in OPEP are faced with serious political problems arising from the reduction of State social expenditures and rising prices of consumer goods due to the fall of tax income. The whole zone has become a powder keg.

The return of the Iranian supply following the lifting of trade sanctions will only reinforce the tendency toward lower oil prices. The initial messages from Teheran confirm their plans to export all the crude oil that is possible, which will further increase the excess supply.

The other view on the fall of prices is related not so much to the “excess supply” of crude oil, but rather to the “lower demand” originating in the deceleration of the economy, particularly in China, Brazil, Russia and the European Union. This, in addition to a warm winter that has reduced the demand for heating in Japan, Europe and the United States. It is also worth noting that all commodities have been devalued, not only petroleum, expressing a strong contraction in commodity markets. At the present time it is estimated that the daily offer of crude is at one or two million barrels more than the demand. Hence it seems quite clear that the price of petroleum has fallen because of the economic crisis more than from geopolitical speculations.

Future prices

It would be adventurous to make prognostics on the future prices of petroleum. There are too many factors that influence the game and accurate projections are rare. In principle, one would expect the low prices to raise demand and thus liquidate excess petroleum, when prices may rise again. But this is not likely to happen this year.

On the other hand there are too many governmental bodies interested in maintaining low prices. We have already mentioned Saudi Arabia and its battle against US shale. But a difference between Saudi Arabia and the US is that in the former, the petroleum and the oil company are State-owned, whereas in the United States they are privately owned. It remains to be seen how far domestic interests prevail over the geopolitical ones and to what extent the Obama administration will be willing to attempt to destroy other petroleum economies such as those of Saudi Arabia, Russia or Venezuela. In addition, we should note that the US public is very happy with the low domestic gasoline prices.

Russia has seriously devalued their currency, so that dollar income translated to rubles has remained relatively constant, in spite of the drop in the price of petroleum. Something similar has happened with other exporting economies such as Brazil or Canada. The balance between the costs of currency depreciation and the fall in dollar income from exports has different results according to analysts and a unanimous response is not possible.

What is certain is that investment in oil exploration and exploitation fell by 20% in 2015 and had already fallen 15% in 2014. Drilling rigs in the world have been reduced by 40% over the past year (3) and several companies have gone bankrupt. Investing in oil is probably no longer such a safe bet as in previous years. New investment has been concentrated in shale oil in recent years (and there are almost no conventional reserves left to discover) and these past years have demonstrated the fragility of the sector in face of the fluctuations in the prices of crude. That petroleum companies are going bankrupt is the best proof that the era of cheap petroleum has ended.

Fluctuations and chain reactions

Oil prices have always fluctuated. When their values are low, the economy grows, demand increases and the price begins to rise. When the prices are high enough to hurt the economy, then a deceleration begins and with it a fall in demand, so that low crude oil prices return. This cycle has been repeated periodically over the past fifty years.

Nevertheless we are now facing a structural change in this cycle: conventional petroleum is running out (a majority of oilfields are already in decline) and the unconventional oil cannot be extracted for less than 100 US dollars per barrel. This means that the new floor of the petroleum cycle must be above this value.

This “excess supply” of crude oil that we are seeing today is the result of speculative investments in US shale oil that survived and produced huge quantities while the price was over 100 US dollars. Below this threshold the companies cannot survive. Once the deposits, at present full, are emptied and demand returns to its growth, prices will rise again.

But the investors are already aware. Shale oil will not tolerate price fluctuations and the comings and goings of the economy that worked with conventional petroleum. The banks are alerted: they will not find the expectations of profits related to unconventional crude so convincing. In addition petroleum faces two powerful competitors; the advance of technologies for the employment of renewable sources and the international agreements to limit climate change.

The current drop in prices is due to increased supply combined with lower demand. Once both of these terms of the equation are balanced, the cheap price of crude oil is unlikely to return.

But petroleum is not just another commodity. It is the most versatile and utilitarian source of energy to drive the economy. Cheap petroleum is what has favoured global economic expansion during the past sixty years. And every time that petroleum has risen or become scarce, the global economy has suffered. It does not appear it will be easy to restore global economic growth with energy sources that are less versatile and more costly. Ensuring peace and future sustainability must go hand in hand with a global economy that is less dependent on energy supplies and — probably — more austere.



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Gerardo Honty is an analyst with CLAES (Centro Latino Americano de Ecología Social); he reports for the CLAES portal Published in ALAI (Agencia Latino Americana de Informaciones) on February 12, 2016; translated for ALAI by Jordan Bishop.