Self-drowning in oil

[abomvubuso.livejournal.com]

The Stone Age didn't come to an end for a lack of stones, the same way the oil epoch won't end because oil would run out, sheikh Ahmed Zaki Yamani, the Saudi minister of oil warned back in the 70s. Now his words are being regurgitated by people like Herman Gref, a prominent Russian banker who recently said the time of carbon fuels is almost over - maybe there'll be some final 10 years before it dies completely. Russia is one of the biggest losers in that respect, by the way, because it has failed to adapt its economy to the new realities.

Granted, the end of oil has been predicted many times in the past, and these predictions have always been debunked by reality. But the latest months are showing a different trend: from the beginning of the year, the oil prices have slumped by nearly 1/3, making the overall dip for the last year and a half about 75%. For the first time in more than a decade, a barrel of Brent crude could plunge below $27. Iran's return to the stage after the lifting of the sanctions will compensate potential cuts in other countries, and the market could get over-saturated, and self-drowned, MAE has warned. But more importantly, the fracking revolution has put something like a ceiling on oil prices: in case of a sharp price hike, the currently losing US producers could again become profitable, and OPEC would have to think hard about its market share. Meanwhile, the share of renewable energy will be rising steadily, which puts yet another ceiling.

Except, there are now concerns that this time the classic equation won't work, and the benefits won't be as apparent. The oil countries and the industry as a whole are already feeling the shock - it's affecting the otherwise already depressed financial markets, which are suffering from a nightmare start of the year, and this could hit the consumers' and business confidence pretty hard. The concern is that global growth is so anaemic that even super-cheap oil woulnd't be of any help. In the meantime, the price slump could potentially re-write not just the oil market but geopolitics as well, because it's being most severely felt by some major rivals like Saudi Arabia, Iran and Russia, all heavily involved in the Middle Eastern conflicts.

After the sanctions were lifted off Iran, that country has been bracing itself for a field day. Tehran promises to immediately start releasing half a million barrels daily. As MAE has noted, there's considerable uncertainty about the quantity and quality of the oil that Iran could offer in the short-term, and there are a number of challenges in finding proper customers who'd be willing to buy even more oil at a market that's already flooded with it. Even if Iran's return to the stage doesn't turn out as quick and ambitious as initially thought, their feud with Saudi Arabia guarantees that even if OPEC wants to, they might not be able to manage the oil prices as much as they want (and to the extent that they used to).

There are also suspicions of the presence of some other, less visible factors dragging the market down. The Standard Chartered bank for example has made an analysis, warning that the prices might have to go down to $10 before the speculators finally acknowledge that things have gone way too far. The BP CEO Bob Dudley has forecast in Davos that oil could even plunge below $10 as soon as the first half of 2016 (although it won't remain at that disastrous level for too long).

Speculation or not, it's a fact that the market is currently drowning in oil. Saudi Arabia is pumping out almost at full capacity, 10 million barrels a day, and remains deaf to Venezuela and Nigeria's pleas for an urgent OPEC meeting that would negotiate a cut in production, and a price stabilisation. The reason is that the Saudis have a different goal: they're protecting their own market share. And they're prepared to endure some pain for the sake of pushing the more high-expense producers off board, particularly the US fracking companies. The severe rivalry with Iran is also a reason that Saudi Arabia could tolerate cheap oil for the sake of undermining the positions of their foe, and preventing their own market domination from being threatened, as well as amassing some money that could help them in their geostrategic projects.

Except, the fracking boom in America has turned out far more resilient than some in Riyadh may've hoped. Although the oil wells currently working on the US mainland may've diminished in numbers almost by 2/3 compared to their 2014 peak, production remains stable - mainly because it's getting more efficient. For instance, the shale industry in the US has cut about 100 thousand jobs, most in 2015, and the market graveyard is filled with dozens of bankrupt companies - but that hasn't stopped US production from increasing by thousands of barrels per day.

The effect of low oil prices on the plans of the oil companies is quite brutal, really. The value of the investments that have been either canceled or frozen because of the market collapse now amounts to $ 380 bn, a Wood Mackenzie report says. Another 170 bn are at risk. BP is planning to cut 4000 jobs, Shell will cut 6500, Chevron 7000, etc. The banks are already panicking about their energy portfolios.

Wood Mackenzie has calculated that even at $30 a barrel, only 6% of the global production will be capable of covering their production costs. This sort of unsustainability is just one of the reasons for the forecasts that cheap oil is only a temporary phenomenon. The market will remain over-saturated in 2016, MAE predicts, and supply will keep exceeding demand by 1/3 (almost 1 million barrels per day). There'll be huge pressure on the oil industry's ability to absorb these quantities efficiently.

This situation is already starting to affect Saudi Arabia itself. The kingdom has registered a budget deficit for two years in a row (now at the record $98 bn), and for the first time since 2007 they'll be forced to use their financial reserves, and even issue state bonds on the loan market. The central bank's reserve has shrunken from $732 bn to $623 bn for 2015 alone, and the current expenses and given the lack prospects for a change at the oil market, the fiscal buffer is going to melt away in 5 years.

The combination of cheap oil and military intervention in Yemen, as well as the Saudi support for the Syrian rebels, is making their position rather unstable. The defense expenses are swallowing more than 1/4 of their budget now ($56.8 bn). IHS forecasts indicate that this could increase do $62 bn by 2020 if the Saudis do not scale back some of their military interventions in the region.

On the upside, low oil prices could in principle be a stimulating injection for the economy. Cheap fuel, as well as lower utility bills and smaller transportation expenses practically have the effect of a tax cut, leaving more resources at the disposal of both households and business. In principle, a 10% oil price decrease brings a 0.5% economic growth.

All that being nice, there's a fundamental problem. Oil prices tend to move in parallel with (or a bit in ahead of) those of other essential materials. And these all, in turn, are affected by global demand. Right now, the oil price slump could partially be attributed to the slowing Chinese economy. It not only needs less oil, but also copper, steel, cotton, etc. As soon as it does get a breath of fresh air (which it will, because of the lower prices of these essential materials), it's likely to resume its booming growth. In fact, it's right then that we'll see if the end of the oil era has really come, or this is just a temporary glitch. If the prices of the essential materials start growing faster than the oil prices, that would be an indication that yes, the oil epoch is coming to an end.

Nothing of the sort seems to be happening for the time being, though. For instance, on Jan 19, the very news itself that the Chinese growth wasn't as bad as initially anticipated, led to a 5% growth in the oil futures at the ICE Futures Europe exchange. In the mid-term, investors are also very skeptical about these predictions of an impending end of the oil epoch. The CME Group data forecasts almost three times higher fuel prices at the European market, starting from mid 2017.

Naturally, every abrupt change of the material base of the economy brings unforeseen consequences. At the beginning of the 20th century, the British navy decided to shift from coal to oil, which gave it huge advantages in WW1 compared to the German one. But this brought the end of the British coal industry, and placed the Middle East on the geopolitical map. The end of oil could in turn ignite that powder-keg, as the current tensions between Iran and Saudi Arabia indicate. The visible US withdrawal from the region (due to the US not being so dependent on Gulf oil, plus the reluctance to get entangled in yet another quagmire) are among the reasons for the US non-intervention in the Syrian bloodbath. Which in turn has pushed milions of refugees towards Europe. Now imagine what the lack of funds for the Gulf regimes could cause.

The shrinking significance of oil would have other unpredictable long-term consequences as well. For instance, would the Middle East countries be as serious a source of investment for the world economy? Most of the oil revenue in the OPEC countries is being invested in Western economies, which has driven the stock markets forward.

The collapse of the Russian ruble and the hectical privatisation of state assets has made even a staunch Kremlin propaganda tool like RT ask themselves if the Black Tuesday (Dec 16, 2014) isn't coming back. The devaluation of the Russian national currency, which is mostly caused by the oil prices, will render a number of major investment projects unviable, and will hit the tourism sector in a number of regions around the world.

Sure, we should be cautious about predicting the end of the world as we know it. No doubt the end of the oil era is being a bit overestimated. If anything, because it won't happen that quickly, anyway. Besides, making direct analogies with the past could prove to be a tricky exercise. Everyone who's expecting Russia's collapse in a scenario similar to the Soviet one (the Soviets suffered very badly from the low oil prices), is probably in for some disappointment. The USSR collapsed mostly because the Russians were fed up of communism. Now the Russian president is taking one military adventure after another, just as the Russian economy is in recession and the oil price is steadily plunging. But the sharp turn has already become quite apparent, and some of the players are preparing for it and are going to survive it - while others will fly overboard.