By Gerardo Honty
Crisis in conventional and unconventional oil
At the beginning of this century, the threat of the “peak” of oil (maximum possible world production) hovered over the analysis of the oil market. The obvious expected restriction in the supply of crude oil led investors to direct their resources towards a new technology: “shale oil” and “tight oil” (oil from shale or compact formations). The expectation of high prices sparked a "shale revolution" in the United States. The consequence was that as of 2010, oil production in that country went from 0.5 to 4.5 million barrels per day in 2014 (1).
But the machine killed the inventor and the US supply flooded the market, which together with the slowdown in the economy caused prices to fall. US oil companies began to cut costs, sold assets, cut the number of wells to less than half, but most companies managed to survive. However, already below $ 50 a barrel, drilling companies such as Samson Resources and Magnum Hunter Resources have filed for bankruptcy and others (such as Chesapeake, Southwestern Energy and Ultra Petroleum) are expected to follow.
If prices remain below US $ 50 a barrel of oil, the shale crisis in the United States could drag down the banking and financial institutions that made it viable, as was warned by several analysts (2). But the crisis not only affected the North American oil companies: BP has announced the reduction of its workforce by 15%, Pemex reported that it will lay off 13,000 workers, Shell has sold part of its assets, just to give a few examples.
OPEC meanwhile kept its production volumes high (at lower costs than its shale adversaries) in a bid to demolish North American industry, according to some analysts. However, this strategy is dangerous as it affects the economies of the Arab countries and other oil states. To such an extent that the Saudi government is studying the possibility of privatizing some sectors of the national oil company, Saudi Arabian Oil Co. (Saudi Aramco). This is the only Saudi oil producing company, it has the second largest oil reserves in the world, and controls the production of more than 10% of the world's oil.
In Saudi Arabia, the 2015 deficit reached 98 billion dollars (double the expected) and domestic oil prices have risen by 40%. Similar measures have been taken in other countries such as the United Arab Emirates and Venezuela. The Arab states of OPEC are facing serious political problems that trigger the reduction of state social spending and the rise in prices of consumer products due to falling tax revenues. The whole area has become a powder keg.
The re-entry of Iranian supply after the lifting of trade sanctions will only reinforce the trend towards low oil prices. The first messages launched from Tehran confirm its plans to export all possible crude, which will only increase the oversupply.
The other look at the fall in prices is related, not so much to the “oversupply” of crude oil, but rather to the “under demand” caused by the slowdown in the economy, particularly in China, Brazil, Russia and the European Union. Added to this is a mild winter that reduced the demand for heating in Japan, Europe and the United States. It should be noted that all raw materials have been devalued and not just oil, expressing a strong contraction in the markets for raw materials. At present it is estimated that the daily supply of crude is one or two million barrels above the demand. Therefore, it seems quite accurate to assume that the price of oil has fallen due to the economic crisis, rather than due to speculations of geopolitical power.
Forecasting future oil prices is an adventure. There are too many factors that influence the game and in fact the projections that are fulfilled are few. In principle, it is to be expected that the low prices will end up raising the demand and the oil surpluses will be liquidated with which the prices could rise again. But this would not happen during this year.
On the other hand, there are too many government actors interested in keeping prices low. Saudi Arabia and its battle against the American shale have already been mentioned. But unlike what happens in Saudi Arabia where the ownership of the oil and the company is state-owned, in the United States the ownership is private. It is necessary to see to what extent domestic interests weigh over geopolitical ones and to what extent the Obama administration will be willing to try to destroy other oil economies such as that of Saudi Arabia, Russia or Venezuela. On the other hand, it should be noted that the American public is very happy with the decline in domestic gasoline prices.
Russia, for its part, has greatly devalued its currency and therefore revenues in dollars converted to rubles remain relatively constant despite the fall in the price of oil. Something similar happens in other exporting countries such as Brazil or Canada. The balance between the costs of the depreciation of the currency and the fall in dollars of exports has different results according to analysts and a unanimous answer cannot be given.
The truth is that investments in oil exploration and exploitation fell by 20% in 2015 and had already fallen by 15% in 2014. The world's "drilling heads" (rigs) have been reduced by 40% in the last year (3) and there are several bankrupt companies. Investors may not be as safe to invest in oil as in previous years. New investment has been concentrated in recent times in shale oil (there are almost no conventional reserves to discover) and these last two years have shown the fragility of the sector in the face of fluctuations in crude prices. That the oil companies are failing is the best proof that the era of cheap oil is over.
Fluctuations and chains
Oil prices have always fluctuated. When their values are low, the economy grows, demand increases and the price begins to rise. When prices are high enough to hurt the economy, then the slowdown begins and with it the fall in demand, bringing low oil prices back. This cycle has been repeated periodically in the last fifty years.
However, we are now facing a structural change in this cycle: conventional oil is running out (most of the fields have already gone into decline) and unconventional oil cannot be extracted at less than USD 100 per barrel. This means that the new floor of the future oil cycle should be above that value.
This “oversupply” of crude that we are experiencing today is the result of speculative investments in the US shale that survived and produced huge amounts of volumes while its price was above USD 100. Below that threshold, companies do not survive. Once the currently full deposits are emptied and demand resumes growth, prices will rise again.
But investors are already warned. Shale does not tolerate the price fluctuations and economic swings that conventional oil did. Banks are on alert: earnings expectations related to unconventional crude should no longer be so convincing. Oil also faces two powerful competitors: the advancement of technologies for the use of renewable sources and international agreements to limit climate change.
The current drop in prices is due to oversupply combined with underdemand. Once both terms of the equation are rebalanced, it will be difficult for crude oil to return to cheap prices.
But oil is not just another commodity. It is the most versatile and utilitarian energy to power the engine of the economy. Cheap oil is what has fueled global economic expansion for the past sixty years. And every time oil has risen or scarce, the global economy has suffered. It does not appear that it will be easy to sustain global economic growth with less versatile and more expensive energy sources. Ensuring future peace and sustainability should go hand in hand with a global economy less dependent on energy inputs and - probably - more austere.
2. See for example: http://www.postcarbon.org/drill-baby-drill and http://shalebubble.org/wall-street/
- Gerardo Honty is an analyst at CLAES (Latin American Center for Social Ecology); report for the CLAES portal www.globalizacion.org.