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Is this a new paradigm for oil prices? BP chief economist reviews changing world oil market as shale oil upturns conventional thinking and global warming concerns grow ALAN BAILEY Petroleum News
About the only predictable characteristics of the global oil price appear to be its volatility and unpredictability in the face of a complex world oil market. But is that market, and hence its oil-price ramifications, now undergoing fundamental change? In a paper presented in mid-October at the Society of Business Economists Annual Conference, Spencer Dale, BP chief economist, suggested that dramatic changes are happening in the oil market, with these changes requiring a corresponding transformation in how to think about oil-price drivers. And the new economics of oil will have fundamental impacts on economies, financial markets, businesses and families across the world, Dale thinks.
Dale characterized conventional thinking about the oil market as revolving around four basic principles: upward price pressure as oil resources become increasingly scarce; price instability as a consequence of steep supply and demand curves; an overall flow of oil across the world from east to west; and the stabilization of the oil market by the Organization of Petroleum Exporting Countries, or OPEC.
But two fundamental changes in the oil market in recent years have upturned traditional oil economics, Dale thinks. Those changes consist of the shale oil revolution in the United States and the increasing level of concern about carbon emissions and global climate change.
Increasing oil reserves The theory of increasing oil scarcity derives from the concept that there is a known, finite stock of recoverable oil resources, with oil prices rising as the scarcity of oil increases relative to the availability of other goods and services. But, in practice, with new oil discoveries and evolving oil production technologies, proven oil reserves have actually increased over the years, Dale wrote. In the past 35 years, while the world has consumed about 1 trillion barrels of oil, proved remaining reserves of oil have increased by at least double that amount. And total proved reserves are now almost two-and-a-half time greater than in 1980, he wrote.
As a prime example of technical progress, the U.S. shale oil industry, involving the production of oil from relatively impervious rocks using high-tech drilling and hydraulic fracturing, achieved an average annual productivity growth of 30 percent between 2007 and 2014, Dale commented.
Moreover, the burning of all known reserves of fossil fuels, including oil, would emit into the atmosphere an amount of carbon dioxide well in excess of double the amount considered to be a maximum for keeping global warming at an acceptable level. And that does not take into account the burning of fuel yet to be discovered or yet to be booked as reserves, Dale wrote.
Given all of these considerations, there is no underlying reason to anticipate long-term growth in the relative price of oil. And it is likely that world oil resources will never be exhausted, Dale suggested.
Dampening price volatility? The traditional volatility of oil prices results from the historical fact that the rates of oil production and oil consumption have both been relatively insensitive to price, so that a change in either the available oil supply or the demand for oil can trigger quite a large price swing. Oil supply tends to be insensitive to price because conventional oil fields typically take several years to develop and then continue to produce oil for many years thereafter. Oil demand has been insensitive because of a lack of short-term substitutes for oil as a source of needed energy, Dale said.
Shale oil, however, involves the drilling of many relatively short-lived wells, a development characteristic that enables drilling and development decision time spans to be measured in weeks rather than years. Moreover, with most shale-oil development costs being variable, tied to production rates, rather than being the fixed, up-front costs of field development, shale oil production rates can respond flexibly to oil price signals: It is likely that shale oil will act as something of a buffer, dampening oil price volatility, Dale thinks.
However, the tendency of much U.S. shale oil development to be conducted by small companies with high levels of leveraged funding does make shale oil production vulnerable to the impacts of financial shocks in the economy, Dale wrote.
The historic flow of oil east to west, from the Middle East to Europe and the United States, is being disrupted both by a major growth in U.S. oil production, thanks to shale oil, and by a drop in oil demand in the west, thanks to improved vehicle fuel efficiency. Moreover, fuel efficiency gains are likely to quicken over the next 20 years, Dale suggested. The United States is likely to become self sufficient in energy by the early 2020s and in oil by the early 2030s, he wrote. At the same time, oil demand is growing fast in the east, in India and China in particular, Dale wrote.
This sea change in the global flow of oil will likely have major impacts on global flows of finance, and hence on national current account imbalances around the world, Dale suggested.
Limited OPEC impact In terms of OPEC’s impact on the oil market, Dale wrote that in his view the cartel’s long-term influence has tended to be overstated and that OPEC’s role has not fundamentally changed in the past 20 to 30 years. While it is true that OPEC can respond to temporary shocks in the oil market by adjusting oil production rates, the organization has never had the ability to stabilize the market in the face of long-term structural shocks, such as fundamental, persistent changes in energy usage or energy supply, Dale wrote. OPEC cannot wage an effective war against U.S. shale oil, any more than it could against the widespread use of electric cars, should game-changing electric car technology be invented, he suggested.
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