Turmoil for Oil – Does the World Now Face an Era of Ultra-Low Prices?
Scott Montgomery argues that, all things considered, ultra-cheap oil is not the world’s friend.
Oil shocks happen when prices suddenly ascend or crash. In the past, a skyward soar in prices was understood as a bad thing--bad for consumers, for economies of importers, and for geopolitics—while a sustained plunge merited celebration for the same reasons, inverted. Yet this paradigm no longer works for the world that now exists. The new world of a changing climate, global interconnection, and return of America as oil exporter, has turned the calculus of the past upside down. Cheap oil, especially ultra-cheap oil, is no longer a benefit. We might even call it a kind of threat.
In the first two weeks of March (2020), global prices collapsed by more than 30%, an impressive fall. In truth, they have tumbled harder and further than most people realize. Since January, when a downward slide began, prices have been more than cut in half, from $69/bbl to around $33-$34/bbl. Knowledgeable readers will know that this does not approach the massive crash between late 2014 and early 2016, when Brent (a global marker crude) descended from $106 to a low of $28 (a fall of 73%).
But the low didn’t last. Within six weeks, oil was up to nearly $50 and went on to $60, where it largely remained, as an average, until this year. The difference today is that the forces working to keep prices down are multiple and could be lasting. It is now possible (some say probable) that the world faces an extended period of very cheap petroleum, the likes of which haven’t been seen since the 1990s, an era that birthed the SUV and many other forms of unbridled consumption and dependence. Will this happen again, really? Perhaps not in Europe and a few other places. But then there is the rest of the world to consider.
No one knows, or can know (though some will came to), how long will the new low-price period will continue. If its arrival was unanticipated, so will be its departure. All the more reason, however, to examine its causes and effects and to consider its longer term impact if it remains the norm.
What Happened? Demand, Supply, and Liquid Politics
Oil has been hit equally from both the demand and supply sides. Demand for petroleum fuels has fallen worldwide because of response to the coronavirus. This is true everywhere, throughout the globe, and will continue to spread and deepen with the pandemic. Nowhere was this more important early on than in China—sealing off villages, towns, and cities, quarantining hundreds of millions of people, and more led to closed factors, broken supply chains, hugely reduced transport at home, and scaled down travel and trade abroad. This is key, because China has been the globe’s largest oil importer. Still more, it has been responsible (even during the trade war with the US) for as much as 80% of global growth in demand.
Yet even as China seems to be recovering from the pandemic, the rest of the world is not. Were Chinese economic production to ramp back up toward previous normal, it would do so in a world that is going into hibernation, soon to suffer recession, unable to buy its goods at anywhere near earlier levels.
Moreover, a big return focused on Chinese domestic economic and transport activity would not alter the oil price situation either. China consumes around 14% of global oil supply, a big number, to be sure, but not big enough to wag the entire dog for too long. At the start of this year, China imported an average of 10.1 million bbls/day, while the figure for the EU was over 15 million bbls/day, the U.S., 9.1 million bbls/day, Japan and South Korea another 6 million bbls, and for the emerging economies of India, Philippines, Thailand, and Turkey, around 8.5 million. Eroding demand for petroleum fuel in all these places, in response to the pandemic, will wipe out any increase in China.
There is no separating the turmoil in oil from the chaos brought by the coronavirus. At this writing, near-term control over the pandemic does not appear in the realm of possibility.
At least 114 countries have documented cases of the disease, and very few have taken, or are able to take, the kinds of draconian measures adopted by China or the early and efficient methods of South Korea (an effective test developed in just three weeks and made widely available, while most gathering spaces were quickly closed). Data gathered and continually updated from dozens of nations suggests that the pandemic will continue into the later part of the year at the very least.
Continued erosion of demand for transport fuels is therefore not only a given but may accelerate, as more of humanity ceases to drive, fly, and sail. The world’s major economies, meantime, seem to be hurrying toward recession. This may not seem to matter, when so much commercial and business activity are going on hold. But, as we know too well, with wreckage of another economic collapse still smoldering before our eyes, such a turn down, with large-scale job loss in every sector, would add much blood, sweat, and time to recovery. It would be wrong to make any prodigal predictions along these lines at this point. It would be legitimate, however, to consider that the pandemic might bring illness to more than the physical body. All of which gives reason to anticipate downward pressure on the price of petroleum may well outlast the pandemic itself.
This conclusion is doubled on the supply side. Here there has been a bitter breakup of the OPEC + Russia arrangement and a resulting war for market share. Oil, it should never be forgotten, is liquid politics. OPEC and Russia first got together in 2016 to cut production and raise prices against a river of new oil flowing from shale drilling in the U.S. To a degree, as noted above, it worked—prices did rise, from the low-$30s to as high as $70-$80 (per barrel), though in volatile fashion.
But at the recent meeting on March 6, the Saudis proposed a big new cut to counter the demand collapse. Russia said no. Enough was enough; it was time to raise production instead, to take market share back from the shale people. The Saudis responded that this was an error, but it forced their hand to raise output too. A few days later, perhaps as the result of persuasion from Saudi Crown Prince Mohammed bin Salman, the United Arab Emirates (UAE) stated they would also flow their wells to the full and accelerate plans to develop even more capacity.
Russia’s motives seem evident. Suffering under sanctions for its seizure of Crimea, keeping wells shut-in as U.S. producers gain market share, the prospect of taking another cut, even a small one, did not sit well. Neither did allowing Saudi Arabia to continue calling the shots. Russia is its own master and may agree to shared policies as long as they match its own national self-interest. History has repeatedly shown Saudis and Russians to be the best of enemies in the domain of oil.
There is little doubt, too, that U.S. shale companies are especially vulnerable right now. Many have operated along the jagged edges of profitability and remain deep in debt. With demand falling, an added downward push on prices would surely bring pain to the plains of Texas, North Dakota, and Ohio. Indeed, it already has. Even before the crash to $30 oil, shale companies were reducing budgets and cutting drilling plans due to the price slide since the beginning of the year. More, along with bankruptcies and a fall in financing, will follow. As if this were not enough, the U.S. coronavirus epidemic has also begun to impact the drilling and servicing of wells, along with other parts of the business.
What is the Outlook?
The Russian calculus was likely accurate, then, at least to a point. But it probably didn’t include the Saudi-UAE response. Russian companies, notably the state-owned ones, Rosneft and Gazprom, can probably raise production by around 200,000-300,00o bls/day in the short-term. They claim they can elevate flow by 500,000 bls/day in 2020, but this may exaggerate the case unless new drilling is done. My own estimates suggest that, together, the Saudis and Emiratis can boost flows by as much as 3.5 million bls/d—possibly 10 times the Russian volume—over the rest of this year. The comparison shouldn’t be lost on anyone.
And even without any of these increases, the global market was already above flood stage. According to the International Energy Agency’s Oil Market Report for March 2020, the fall in demand and rise in shale production would have left the global market oversupplied by 3.5 million bls/d unless OPEC made big cuts. Even if the shale retreat is as much as 3 million bbls/day, the total surplus in global supply will still be on the order of 4-5 million bbls/day. And this doesn’t include the high volumes that are now sitting in oil stocks around the world. As things stand now—with the proviso that they never stand in one place for very long—the outlook for the world going into the 2020s is for an era of ultra-cheap petroleum.
What of geopolitics? Asking which nation might win the war for market share might therefore be the wrong question. It is perhaps better to ask who will suffer less. The answer would seem to be the Saudis, given their lack of sanctions and level of spare production capacity. But buyers can be choosers in a low-price market. Russia is the big supplier to Europe right now, while both exporters are competing for Asian markets, which have become the center of demand in the past decade. Here, Russia has an advantage. It has pipeline connections and shorter transport distances that make things less costly. But at ultra-low prices, this may not matter as much.
The Saudis, meanwhile, have had their eye on increasing imports to Europe for some time. Almost immediately after the spat with Russia, they announced an $8/bbl discount (price of $25/bbl) for European buyers. The Kremlin tried to shrug this off, saying it could live in a low price world for years, even a decade, drawing life from a sovereign wealth fund of $150 billion. Few experts, however, believe such bluster. Given the many needs of the nation, its plans for social and military spending, not to say investment in its oil and nuclear power sectors, the country’s economy would resemble the ruin of an abandoned Soviet factory well before the fund was half gone.
This brings us to the U.S., great disrupter of oil geopolitics. Between 2010 and 2014, drillers of shale (and other low-permeability or “tight” reservoirs) upended OPEC’s supply power, which had stood since the oil crises of the 1970s. When prices went over a cliff in late 2014, it was largely due to the production flood in America (this greatly lowered US imports, which meant a rapidly rising surplus of oil on the global market). Lower prices in the following years—at around $60/bbl, still about half of what they’d been since 2011—did hurt many shale companies. But it strengthened others, who returned with vengeance after 2017.
Fundamental laws of economics do apply at times. Forced to adapt or die, companies evolved. They merged, became more efficient, streamlined their drilling techniques, shortened the time needed to drill and complete a well, and innovated in other ways to reduce their costs. They sold off leases on land that was less prospective, concentrating on richer, more productive areas. More than a few firms did fail or were eaten by bigger rivals. But those that survived did come back stronger. Theirs was not a death foretold. Nor is it now. Pain there will certainly be once again, but the demise of shale production has been greatly exaggerated more than once.
What, then, of the consumption side? Here, too, history may not exactly repeat itself, but it does create echoes and provide analogies. In 1986, the Saudis opened the spigots against rising production from the North Sea and, more importantly, the Soviet Union. The result, as mentioned, was an entire generation of cheap oil, lasting until demand from emerging economies, China most of all, forced prices higher starting in 2004. The impacts for the U.S. and most of the wealthy countries were ugly. Narcosis about energy issues set in. Oil consumption steadily rose and so did imports from OPEC nations, especially those in the Middle East. In America, cars, minivans, pickup trucks all grew bigger and more powerful, as well as less fuel efficient. There was more U.S. military intervention in the Middle East to protect oil routes, more bases, more propping up of dictators at the same time as calls for democracy, aiding the advance of terrorism. Can we blame the U.S. invasion of Iraq on cheap oil? No, that would be much too simple. Can we wholly separate them? Again, no.
Little of this can happen again. But it doesn’t matter. Ultra-low prices, which cannot be separated from impacts of the pandemic, would bring new negatives, no less worrisome.
Like the following:
Significant economic damage in oil-producing countries beyond OPEC and Russia, like Argentina, Brazil, Guyana, Ivory Coast, Malaysia, Indonesia, Azerbaijan, Kazakhstan, Mexico, Colombia, Oman, South Sudan, and (lest we forget) the U.S.
Major economic and possibly social disruption in oil-exporting nations with fragile democracies, like Iraq, Algeria, Nigeria, Gabon. Iraq is a particular worry, given its partial emergence from war and insurgency.
Bankruptcies, unemployment, rural decay, elevated drug use, “deaths of despair” likely in U.S. states where the oil boom is active (e.g. Texas, New Mexico, Utah, Colorado, Wyoming, North Dakota, Alaska, Ohio, among others.
Lack of any economic boost from cheaper oil due to massive recession in most nations due to the pandemic, which, again, shouldn’t be separated from what is happening in the global petroleum market.
Ultra-cheap carbon fuels that might turn public interest and vehicle manufacturer incentives away from higher fuel economy and efficiency, including non-transport uses.
Cheap fuel as a possible hurdle to all-electric transport, now at a critical period, as major car and truck manufacturers bring out full lines of EVs between 2020 and 2025.
Major decline in the value of recyclable plastics, thus in recycling (without government support), as manufacturing new plastic becomes cheaper than the cost of recycling.
Even more importance placed on government policy to advance action for lowering emissions, therefore giving politics an even greater influence in a sphere where local and national political leaders have not (yet) proven everywhere reliable.
Increased use of petroleum fuels in emerging and less developed nations (transport, power generation, heating), which are now undergoing energy modernization at a significant pace.
The current shock is not yet over at this writing, and more big changes may lie ahead. Though many try to do so, and the era of Big Data has not dissuaded the attempt, forecasting oil market conditions, including prices, is tantamount to predicting history. What can be said with some assurance is that the effects of mega-cheap oil are bound to be diverse and, in some ways, nuanced.
But they are not likely to be beneficial. Yes, if the pandemic is solved and the resulting economic damage is not too serious, ultra-cheap fuel could help recovery in some areas, helping keep food and heating oil prices lower for example. No one should think, however, that all things related to or made from petroleum—an almost incalculable number at this point, from makeup to medicine, clothes to computers—will fall in price or remain more affordable than might otherwise be the case, boosting the economy skyward.
The key point is that ultra-cheap oil is not the world’s friend. There are too many reasons to move away from dependence on petroleum in the domain of fuel. Such a move will be a massive undertaking, to say the least. It will not be aided by another era in which oil is more affordable than bottled water.