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Glimmer of hope amid the falling oil price gloom

Lower oil prices will be tough for the industry, but good for the global growth and demand

Call it an aberration, a slump, or a correction, the near-25% plunge in oil prices in the past three months comes with consequences. Some of the carnage is visible. As a group, the 199 biggest energy firms listed in the US have seen about 17% wiped off their stock. The RTS, Russia’s stock exchange, has fallen by about the same, while the rouble is now a quarter cheaper than it was in July. Against the US dollar, Canada’s loonie has shed 6% of its value.

If $85 a barrel is the new normal for Brent, Opec’s spendthrift producers will start feeling the pinch quickly. High break-even oil prices among producers may be a motivator at their meeting in Vienna  later this month. Only those in the Gulf can keep their annual budgets in surplus  with sub-$100/b oil. Even for more robust economies, such as Saudi Arabia’s, the crunch point is near, say analysts.

Running down some of the large reserves amassed over the past decade may be necessary. Some may need to carry a deficit: no catastrophe, but not ideal.

Across the industry, executives are predicting a tightening of belts. The drop in share prices will make it harder to fund projects. Even before prices started tumbling, capital discipline was a theme of 2014. In costlier regions, some projects were already being shelved.
This sows the seeds for the next oil-price surge, once non-Opec’s supply growth starts to slow and demand picks up speed. How long it takes for that cycle to begin is impossible to say, but it could be a while. Most of light tight oil (LTO) production in the US, the source of the supply glut  in the Atlantic basin, curbing demand for Opec’s crude, remains handsomely profitable at prevailing oil prices.

That’s because oil prices have been high enough long enough to make most LTO output resilient to a price dip. A lot of the costs, including land purchases, are already sunk. Rystad Energy, a consultancy, says  Brent could fall to $60-65/b without taking US shale-oil output lower. Even at $50/b, a year would pass before North American shale production fell, and even then only by 0.5m b/d. The International Energy Agency (IEA) reckons only 4% of US LTO output needs an oil price above $80/b to be viable. 

There are positives from falling oil prices. They offer an opportunity to get a handle on cost inflation. As marginal production is cancelled, some of the labour tightness behind the extraordinary salaries and low productivity of North America’s unconventional oil sector should ease. Rig day rates should drop. A wider slump in commodity levels will cheapen other inputs, such as steel. In Australia, a hit to liquefied natural gas prices indexed against oil should have a similar effect. 

However painful it is for some producers, no one should complain too loudly. Oil prices have been more than generous. For the 20 years up to 2006, Brent’s average price was $40/b. In the eight years since, it was $92/b.

Quite how big a role oil inflation played in the global economic crises of the past six years is debatable. But a doubling in the price of the world’s most important commodity didn’t leave consumers unscathed. It involved a huge transfer of wealth and liquidity from the developed, oil-importing countries, where savings rates are low, to producer nations, which hoarded much of the wealth. US savings in recent years have amounted to about 17% of GDP, compared to about 50% in Saudi Arabia, according to the World Bank. In short, money that was being spent in consumer economies ended up in producers’ bank vaults.

This may now reverse. Ed Morse, an analyst at Citigroup, argued in a recent Financial Times op-ed that if Brent at $80/b filters through, as it should, to weaker gasoline prices, it will give US consumers the equivalent of $600bn a year. This economy-reviving stimulus is being helped along, ironically, by the approaching end of the US Federal Reserve’s bond-buying programme, a different kind of stimulus. As it ends, the dollar has risen, also driving down the oil price. 

The fuel-stimulus idea isn’t as straightforward as it sounds. Cheaper fuel may encourage people to drive more. Which is  another reason the oil industry should see the latest price drop as necessary. A rise in consumption of just 0.7m b/d this year is a shocking number. The IEA forecasts it will move “tentatively” higher next year, to 1.1m b/d. But only cheaper oil will tell us if robust demand growth can be sustained. A rally, on the other hand — perhaps one triggered by deep Opec cuts - would do what high prices have done for the past decade: persuade consumers and oil-buying countries to adjust their behaviour, find efficiencies and do more with less energy.

But demand growth isn’t low this year because cars engines are more economical. The global economy is weak and the recovery remains “uneven”, the IMF said in October, as it   slashed its economic growth forecast for this year to 3.3%. Poor data from Japan, Russia, Latin America and the core of the eurozone hang over global markets.

Cheaper oil won’t rescue the global economy. It will grant some respite. It should also force producer countries to be less profligate, upstream firms to improve productivity, and put some money in the consumers’ pockets. A healthier global economy will bring more demand for commodities. For oil vendors, that is good news amid the gloom.

Christophe de Margerie, who died tragically on 20 October, was a special figure; a man who stood out among peers as much for his maverick, charismatic style as for his forthright views and his eloquence. He will be terribly missed by those who knew him, and especially at Total. He was a friend to Petroleum Economist and, like many others, we were extremely sad to learn of his death. Our thoughts are with his colleagues, friends and family.

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