The last fifteen months or so have seen quite a change in the Crude Oil market. Before then the debate on this blog covered a long period where it seemed that a Star Trek style tractor beam kept pulling the price of the Brent Crude Oil benchmark back to the US $108 level. Happy days for option writers but of course very expensive for you and I and the world economy with only the producer summoning a cheer. Then something changed and the oil price fell and at times plummeted which with the occasional retracement finds us this morning with Brent Crude just above US $49.
An old sparring partner of this blog the former Chief Economist of the Bank of England Spencer Dale he of (create) Inflation, Inflation Inflation fame has opened fire on the subject. So what do we learn? Well the first thing is that for the UK establishment there is no such thing as failure as his departure from the Bank of England at Governor Carney’s behest has been followed by being made Chief Economist of British Petroleum. Also we get as near to an admittal of my critiques of his views as we are going to get.
many of my core beliefs about the oil market stemmed from what I had learnt at school and university.
Monetary policy too Spencer.
The Oil Market changed
One side of the argument is familiar as the regular cries of “peak oil” and supply reducing over time were replaced by this.
From a near standing start in 2010, US shale oil production has increased to around 4.5 Mb/d today.
There are of course shale oil efforts elsewhere on a smaller scale. But this had a big impact.
US oil production on its own increased by almost twice the expansion in global oil demand.
This drove the oil price lower and by a very large amount so we learnt that relatively marginal moves in oil supply/demand ( US shale oil is 5% of total world supply) have very magnified effects on the price in this instance of the order of ten to one.
Also we get an assertion from Spencer that much of shale oil is viable here at current price levels. Whether he actually believes that or whether this represents the interests of BP I do not know.
In the language of the delightful Ms Taylor Swift this is like so over.
Total proved reserves of oil – reserves of oil which, with reasonable certainty, can be economically recovered from known reservoirs – are almost two-and-a-half times greater today than in 1980.
Perhaps Spencer is unaware of the fact that back then oil companies only bothered to search for a few years supply on a rolling pattern. Anyway we then get perhaps the most eye-catching of his quotes.
Put differently, for every barrel of oil consumed, another two have been added.
I am not sure whether the section on climate change is meant to please his old boss Governor Mark Carney who had a recent Road To Damascus type conversion on the subject or his new bosses at BP but the world according to Spencer is heading here.
But even so, the pace at which estimates of recoverable oil resources are increasing, together with growing concerns about the environment, means that it seems unlikely that all of the world’s oil will be consumed.
What about the oil price?
The analysis so far is a backwards looking explanation of what has happened or ex-post if you like. Back at US $108 there were plenty of assertions that oil supply was singing along with the band Muse.
Our time is running out
Our time is running out
Now apparently at US $49 we are told it will never run out! Can you see the problem which is akin to not seeing the wood for the trees? Also it ignores our relationship with oil which is summed up by the same song.
I wanted freedom
Bound and restricted
I tried to give you up
But I’m addicted
Improvements in technology
Whilst I am dubious about assuming that we will “never ever ever ever” (h/t Ms Taylor Swift again) find that oil is running out it is possible and indeed probable that for now and for a while things have changed. One sign of this is shown by looking at something which in other forms is a regular feature of this blog which is productivity.
Productivity growth, as measured by initial production per rig, averaged over 30% per year between 2007 and 2014
This assertion that such methods are like manufacturing where lessons learned can be applied almost as if on a production line leads to quite a few lines of thought. Firstly the economics of the world of shale oil may be better and perhaps much better than we have assumed. Secondly if this has been happening and has been recorded in the official US data then productivity elsewhere has been worse than we have thought. Thirdly the UK has got used to downwards pressure on productivity from the decline of North Sea Oil & Gas which shale oil could potentially reverse and send charging forwards. Also maybe the new higher output levels in the North Sea may be behind at least part of the UK’s productivity improvement in 2015 which is not quite so rosy a thought.
Price changes will be smaller
This is asserted rather against the evidence of the last year but the short-life of shale oil wells apparently leads to this.
its production characteristics should dampen price volatility,
After the 4% fall on Monday in the oil price that is hard to maintain let alone if we look back over events! We might expect more shale oil production should the oil price rise but we also need to note that some of the economics is dodgy especially for a world which is still undergoing the fallout from a credit crunch.
the vast majority of independent producers have negative cash flows; that is, they don’t generate sufficient cash from their operations to fund future investments.
In other words they have to borrow and borrow.Still it gets Spencer a chance to blow his own trumpet and slap his former central banking colleagues on the back.
It seems quite likely that the scale of funding that enabled the US shale revolution to expand at the pace it did over the past 4 or 5 years would not have been available had global interest rates not been close to zero, with central banks using large-scale quantitative easing to encourage investors to invest in riskier forms of assets.
Finally an area where QE has done some good perhaps! I expect central banking speech writers to be already noting that paragraph and getting ready to use it. it certainly beats the repetition of the word counterfactual! Mind you they had best take care as what could go wrong?
But the greater exposure of shale producers to the financial system means the oil market is more exposed to financial shocks.
As ever from our Spencer there are some useful thoughts but also a failure to see the bigger picture. Plainly the advent of shale oil changed things but in my opinion its impact on the oil price was magnified by two factors. Firstly the major banks withdrew from having trading desks specialising in oil and commodities and I do not think it was a coincidence that prices then fell pretty much across the board. This gives a different emphasis to the current disinflationary phase and indeed a different tinge to QE to that provided by Spencer as it was the liquidity provided by it that allowed a “punters city” to thrive.
The other factor is hinted at by Spencer Dale but in a world of fantasy and not reality. We were hardly likely to wake up one day and discover all cars were electric powered and if we did there would be the question of how we would generate that electricity. But there have been genuine improvements in renewable energy. Whilst there are white elephants such as offshore wind generation that relied on a rising oil price to ever look competitive solar power has made considerable advances. Morgan Stanley put it this back in January.
For the first time, the cost of generating electricity from the sun can compete with traditional sources of power in a number of key markets.
Now there are problems such as storage as battery technology has not kept up but over time it will have an increasing impact on energy supply.
There is a catch however which is that solar power relies itself on elements which are in relatively short supply. So the resources and green arguments are complex and rarely thought through. But if someone manages to produce solar power from readily available elements then the game does change.
Meanwhile how is the UK handling what is a complex area? From City- AM today.
Britain could be facing a winter of blackouts, with National Grid warning of the tightest winter power supplies in a decade…The country now has just 1.2 per cent of spare capacity in the system, down from 4.1 per cent last year.
So what we do not need this winter are cold calm days….
Oh and the actual National Grid report has just been published and the margin has “Hey Presto” gone to 5.1% which means that we are likely to feel the pain in our wallets as prices rise as more expensive production methods are bought in. Higher domestic fuel prices with a lower oil price? Of course we could have a mild winter and this does not matter but if we end up paying more we can be sure that nobody in charge will be responsible.