Oil prices will not approach $100 for the foreseeable future, and this will bring significant challenges to the state-owned giants
“When will the world run out of oil?‘ It’s hard to believe that was once a common question, but analysts of past decades forgot to factor game-changing new technologies into their forecasts. In recent years, the world has discovered much more oil than it has consumed, as hydraulic fracturing, new horizontal drilling techniques, and other factors brought previously inaccessible reserves out of the ground and into the market.
In addition, growth in demand for oil has slowed. A bid by China’s leadership to transition that country’s economy from a model driven by manufacturing and exports to one powered by the spending of Chinese consumers has (predictably) slowed economic growth. Gone are the days of double-digit expansion and China’s voracious appetite for commodities of every description, including oil. This shift is irreversible. China can’t return to the old model without giving back the hard won gains of its middle class and provoking a public backlash.
China’s slowdown has hit commodity exporters in Latin America, the Middle East, sub-Saharan Africa, and East and Southeast Asia. From Brazil and Chile to Australia and Malaysia to South Africa and Russia, governments and economies are feeling pain as China’s slowdown deepens. Add uncertainty over Europe’s future with the beginning of negotiations over Brexit, the risk of a return of the migrant crisis as the EU’s deal with Turkey begins to unravel, plus the continued uneven recovery in the United States, and it’s difficult to see where a future surge of oil demand might originate.
As for the supply picture, in the past major oil producers, Saudi Arabia first among them, could quickly and easily rebalance markets by increasing or cutting production. Following Saddam Hussein’s 1990 invasion of Iraq, prices spiked, but the Saudis cooled the market by adding new supply; after the collapse in prices following the onset of the 2008 financial crisis, the Saudis slashed output to ease the pain.
Things are different now. The resilience of smaller US companies at the forefront of the fracking revolution and the relative speed at which they can ramp up production in response to higher prices ensure that the Saudis can’t make a lasting difference in oil prices. If the Saudis cut, the price drifts higher, more U.S. fracking comes back on line, and the added supply brings the price back down. The net effect is a Saudi loss of market share and the realization that, after peaks at $147 per barrel in 2008 and $115 in 2014, oil prices will not again approach $100 for the foreseeable future.
There are four implications of note. One, state-owned oil giants are in big trouble because they are not nearly agile and resilient enough to thrive in a market where production is now more price-sensitive than ever. Inefficiency has never been more expensive.
Two, the Saudis will become even more anxious in coming years because they can’t cut production to reach the oil price needed to provide crucial government revenue. Bitter rival Iran, now free of sanctions, is rapidly increasing production and growing market-share at Saudi expense. Adding to this anxiety is the specter of generational change in Saudi leadership following the eventual death of King Salman and the accompanying doubts that his son Mohammed bin Salman can lead an effort to bring the kingdom and its economy into the 21st century.
Three, lower oil prices leave the Russian economy on an unsustainable course. Vladimir Putin remains remarkably popular, and his government sits atop substantial financial reserves. But over the longer term, Russia will face the same pressure to modernize and diversify its energy-export-dependent economy just as the Saudis and many others do. However, unlike the Saudis, the Russians haven’t yet accepted that they have a serious problem.
Finally, there is one oil-producing nation already on the brink of disaster. Venezuela imports virtually everything except crude oil, and shortages of electricity, water, staple foods, and other necessities have the country on the edge of open conflict. Those within the Chavista movement may soon sacrifice President Nicolas Maduro to preserve their own grip on power. But only a much higher oil price can buy the regime a lot more time, and that’s not on the horizon.
We live in a moment of seemingly constant change. Yet, all of us, oil producers and consumers, must prepare for a world in which crude oil trades at a lower price, the implications of which will only become more important.