In the
1970s, the government of Japan contributed billions in subsidies to their
manufacturing companies to enable them to enter the US market with “offer you
can’t refuse” prices. Japan entered the heavy equipment business and other
Asian nations followed. Japan was cash rich because their sales of better
quality, fuel efficient automobiles surged in the US. The US auto industry was blind-sighted and
lost market share. Japan won again with
the Prius hybrid in 2000, showing that smart engineering was the key to future
sales. The 2005 Prius surged after the 3rd
redesign and other automakers are still struggling to catch up. Kudos to
Japanese engineering.
The
Saudis were also cash rich after the $100 a barrel oil and $4 a gallon gasoline
price era, so they decided to “buy the market” for a while and cut global oil
prices to $30 a barrel. They had good
reason. Fracking in the US led to new
oil field discoveries in the US and the myth of “peak oil” disappeared.
The low
oil prices have forced other oil producing countries to cut back on starting
new projects, but oil production continues for now. US oil production from established drilling
sites continues to increase. Oil
dependent countries with no extra cash like Venezuela are in a crisis. This oil
price holiday won't last long, but it is making “deflation” more attractive to
working-class US citizens.
The
following article gives us some insight to this phenomena. - Norb
How low can oil
prices go? Welcome to the oil market’s old normal, by Steven Mufson, 1/12/16,
Washington Post
AAA Michigan said earlier this month that the average cost of self-serve unleaded gasoline in the state was $1.97 a gallon, the first time the price has fallen below $2 a gallon since March 2009. (AP Photo/David N. Goodman)
How low
could oil prices go? It’s anybody’s guess.
The price
of oil fell to its lowest level in five and a half years Monday, with both
Goldman Sachs and Societe Generale lowering their projections.
Oil price
forecasting is a hazardous business. In June 2014, Barclays was forecasting a
$109 a barrel price in the fourth quarter, nearly $50 a barrel more than what
prices actually averaged in the fourth quarter. On Monday, the price of the
international benchmark crude, Brent, fell to below $48 a barrel in London.
Gasoline prices fell below $2 a gallon in the Midwest and gulf coast last week.
In an
interview with the respected industry newsletter Argus Global Markets published
last Friday, Saudi Arabia’s oil minister Ali al-Naimi was asked whether the
world would ever see $100 a barrel oil again and he said: “We may not.”
Here are
a few things to consider.
First,
it’s important to keep today’s prices in perspective. Today’s price level – and
the enormous cyclical swing in prices since June – is not a “new normal” for
oil; it’s the old normal.
The world
has just endured eight years of historically high crude oil prices, higher than any time since the 1979
to 1983 period when
the Iranian Revolution and Iran-Iraq war disrupted oil supplies from two of the
world’s biggest oil exporters. And that’s after adjusting for inflation.
The four
years with the highest average crude oil prices since the 1860s were
2008, 2011, 2012, and 2013.
So when
people talk about cheap oil, they’re talking about crude oil that is still more
expensive than the average price from 1986 through 2004.
On two
occasions, prices fell to startlingly low levels. In July of 1986 prices tumbled to $10.91 ($23.79 in inflation adjusted terms)
and in December 1998 they sank to $9.39 a barrel ($13.64 after adjusting for
inflation).
Second,
there is always a delay between price signals and actual changes in production
and demand. In the past four years, with very high oil prices, we’ve seen a mad
dash to invest in new projects, from North Dakota to Russia’s Arctic.
Production
from those projects is still coming on line even as new exploration is scaled
back. In November, Petrobras announced the discovery of a huge new offshore
field. In December, even as oil prices fell, Iraq’s oil production rose about
half a million barrels a day, the result of years of investment.
Eventually,
there will be a rebound in prices as exploration is postponed and consumption
goes up. But for the next several months, the oversupply could get bigger by 1
million barrels a day, Barclays said in a new note to investors.
Third,
there is Saudi Arabia. The kingdom is the driving force behind the drop in
prices because it has grown weary of cutting its own oil output in order to
prop up prices enjoyed by other countries, both in OPEC and especially outside
of OPEC.
How
determined is Saudi Arabia? Very. It is now waiting for low prices to
discourage investments in new projects such as Russia’s Arctic, Canada’s oil
sands, U.S. shale drilling, and Brazil’s costly sub-salt projects in deep
offshore waters.
Yes,
these are long-term projects that rely on long-term oil prices, but companies
still tend to pay a lot of attention to what’s happening now.
And Saudi
Arabia can afford to wait. Even though prices have tumbled, Saudi Arabia –
unlike Venezuela – has a large treasure chest of savings from past years and
can weather a long period of low prices. The government is assuming a 32
percent drop in oil-related revenues. In addition, Saudi Arabia has some of the
world’s lowest production costs, rivaled only by Iraq and some parts of Russia.
Production costs in Saudi Arabia are about $4 to $5 a barrel, Naimi said
recently.
The Saudi
oil minister al-Naimi’s interview in Argus Global Markets should send chills
down the spines of oil producers. He noted that “sooner or later, however much
they hold out” high cost oil projects such as wells in Brazil’s sub-salt
offshore region, off the coast of west African, and in the forbidding Arctic
would have to scale back in response to low prices. “Will this be in six
months, in one year, two years, three years? God knows," said Naimi.
"I say Gulf countries, and particularly the kingdom, have the ability to
hold out.”
Naimi
also brushed aside the plight of Russia and Iran, saying that they were not
only suffering from low oil prices but also “from their political behavior” that
had led to sanctions. “Their problem is more basic” than oil prices, he said.
How long
will Naimi have to wait? The surplus oil production is a small percentage of
global consumption, so it’s possible that a disruption in supplies in, say,
Libya and an uptick in consumption in the United States, Europe and China could
bring things into balance. But consumption isn’t just a matter of crude oil
prices. Gasoline subsidies have been slashed in Indonesia and India, fuel
efficiency standards are pushing U.S. carmakers, and Europe’s economy remains
in the doldrums.
Meanwhile,
new production keeps coming online. Take MEG Energy, for example, a producer in
Canada’s costly oil or tar sands. MEG has slashed its capital spending budget
by 75 percent this year, but its production will still go up about 20 percent.
The boom
in U.S. shale oil is perhaps the most important factor. Estimated global
liquids production grew by 1.8 million barrels a day to a total of 92.0 million
barrels a day in 2014. U.S. domestic crude oil production alone increased 1.2
million barrels per day in 2014, up 16 percent from 2013. U.S. shale oil
production has jumped to about 4 million barrels a day in just six years, more
than the output of any OPEC country other than Saudi Arabia. At 8.6 million
barrels a day, U.S. production is at the highest level in nearly 30 years.
How fast
will that shale oil activity drop off? So far, not much. The Baker Hughes rig
count for onshore U.S. drilling fell to 1,684 down 60 from the week before but
still seven higher than a year earlier. Because shale oil wells produce about
half their output in 18 to 24 months, this activity should be highly sensitive
to prices.
But lower
drilling costs, steady improvements in fracking techniques and a focus on
lowest cost areas help offset the effect of lower prices. The EIA said in December that
“projected oil prices remain high enough to support development drilling
activity in the Bakken, Eagle Ford, Niobrara, and Permian Basin, which
contribute the majority of U.S. oil production growth.” The EIA said it expects
U.S. crude oil production to average 9.3 million barrels per day in 2015.
That’s 200,000 barrels a day less than EIA’s earlier projections, but it still
means an increase of 700,000 barrels a day from 2014.
Sooner or
later, though, the cycle will turn. Naimi in the interview with Argus sounded
confident, and patient. "The bet is about the timing of the price
rise," he said, "not about if it will occur."
https://www.washingtonpost.com/news/wonk/wp/2015/01/12/how-low-can-oil-prices-go-welcome-to-the-oil-markets-old-normal/
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