Valuable Insights from Around the Web – Fri 6 Oct, 2017

The Oil Game – Price and output depend on political deals

I found this article over at the Epoch Times very interesting.

Click here for the original posting page.

At the end of last year, many experts thought oil prices would rise during 2017, maybe up to $60 per barrel. As time went by, however, those predictions were revised repeatedly—and each time the revisions pointed south. By the end of July of this year, crude was selling for about $46 a barrel, almost 20 percent lower than at the beginning of the year and about half the level of three years ago. Will oil prices keep dropping with high supply and sluggish demand, or will they recover as producers find a way to limit production?

The current scenario is clear. The world economy is growing, but the recovery after the crisis has been disappointing and the outlook is not particularly bright. Thanks to technological progress, we need less energy for each unit of new output, and technology has also lowered the price of extraction. And there are many more options for increasing energy efficiency, especially in economies like China and Russia, where waste is prevalent.

Oil bears take extra comfort that oil suppliers have so far failed to agree on a common strategy to restrain production. A few years ago, any geopolitical crisis would lead to fear of damaged oil wells and cuts in supply, but today the opposite applies. Whenever there is trouble in Russia or the Middle East, analysts expect other oil producers elsewhere to seize the opportunity to increase their own production and make up for the shortfall.

Since the dynamic of oil demand is unlikely to change, the future oil price will probably be defined by supply.

Oil bulls, on the other hand, say lower prices have affected investment in traditional drilling and exploration, which should lead to a reduction in supply down the line. But they have hardly stopped in the shale oil business.

The reason is again technology: According to consultancy firm Rystad Energy, the break-even point of shale oil extraction in 2013 was $70 to $100 a barrel, depending on the geology and location of the shale deposits. By the end of 2016, the price interval had narrowed and fallen to $30 to $40. And this decline has not stopped.

In other words, oil bulls focus on declining investment and new discoveries in traditional wells on land and offshore, downplaying the role of shale oil. And indeed, shale oil from the United States accounts for about 6 percent of global oil production and about 60 percent of total shale oil output. If they are right, the current market oversupply will soon disappear. Shale oil production, they claim, is unlikely to increase significantly, and the existing supply will not be enough to meet future demand.

Supply Matters

And in one respect, the bulls are correct: Since the dynamic of oil demand is unlikely to change, the future oil price will probably be defined by supply. Here it helps that the outlook for shale oil is not crystal clear. For example, producers might adopt a wait-and-see approach before deciding to expand production. They may want a peek at where oil prices are heading before starting a new round of expensive investments. This can already be observed with several U.S. producers, who have ramped up production at existing facilities while freezing the development of new sites.

Technological improvements are unstoppable and may well extend to traditional oil fields. Hence, technology might create the cost conditions that allow supply to expand further. However, there is also another important factor to consider.

By contrast, if OPEC manages to agree on a common strategy with Russia, stabilizing oil revenue and therefore the regimes in power, the real winner is going to be Moscow.

Traditional oil producers generally respond to what OPEC does. The oil cartel currently controls about 42 percent of global oil production. As a bloc, it is by far the world’s leading producer. Yet it has failed to execute a satisfactory cartel strategy. In the past, OPEC cut production and succeeded in raising prices, but only at the cost of losing market share to non-OPEC producers, who took advantage of the higher prices and expanded their own production. As a result, oil prices fell back to their initial level, and OPEC ended up with a smaller slice of the pie as well as disgruntled members.

Moreover, OPEC’s internal cohesion is fragile and its ability to collude with major producers outside the cartel (notably Russia) will be crucial if it wants to succeed in limiting supply to increase the price. A deal with Russia could be extremely important, as it would also boost the credibility of OPEC’s price strategy. The Kremlin’s political muscle would be useful for keeping reluctant members in line and intimidating nonmembers tempted to get a free ride on OPEC’s (and Russia’s) restraint.

 

But even if there is an OPEC–Russia deal, its effectiveness depends on devising and executing a long-term oil strategy that would include U.S. shale producers, who have their own reasons for avoiding a crash in the price. This gentlemen’s agreement (or lack thereof) would determine the oil market for years to come, and possibly give new shape to global geopolitics as well.

Putin and Trump Deal

Two scenarios could materialize. If OPEC fails to reach an agreement with key nonmembers, we can expect a change of strategy. Rather than limiting production, Saudi Arabia and other low-cost producers will expand output. By driving prices well below $50 a barrel, they will force high-cost producers to cut output and ensure that shale-oil companies think twice before entering the market or drilling new wells.

Of course, this outcome is consistent with the current market sentiment and will be welcomed by oil importing countries. However, low oil prices and tighter budgets in the oil-exporting countries could trigger tensions and even political changes, since the ruling elites will no longer command the resources required to placate their populations.

By contrast, if OPEC manages to agree on a common strategy with Russia, stabilizing oil revenue and therefore the regimes in power, the real winner is going to be Moscow. Russia and Saudi Arabia have already agreed to cut production until March 2018, in hopes of pushing prices comfortably above the $50 threshold and possibly to $60, which is what Russia’s economy needs.

However, oil exporters need a more stable and long-lasting alliance with Russia to become a serious factor in global geopolitics. If such agreements are reached, the real initiative will be in the hands of Vladimir Putin and Donald Trump. Global oil prices would depend on whether Putin can offer the Trump administration enough incentives to restrain shale output (for example, by creating and enforcing a domestic cartel). The odds against this may be long, but if it happens, Russia and OPEC would find it much easier to police their own cartel and curb free riding.

Enrico Colombatto is a professor of economics at the University of Turin, Italy. This report was first published by Geopolitical Intelligence Services.


Comments:
  1. On October 6, 2017 at 2:04 pm,
    John Law says:

    Is this guy serious? Advocating another cartel when the existing one has failed and in tatters?

  2. On October 6, 2017 at 3:09 pm,
    Silverdollar says:

    I don’t think ‘fixing prices within the oil shale industry’ in this country would politically be possible and perhaps not even legal………but it does sound like something trump could get involved with.
    If it happens, it hastens the development and acceptance of other sources of renewable energy so bring it on….