By John Richardson
This withdrawal of stimulus is bringing a period of artificial calm in pricing to an end.
Chemicals company planners, as they prepare their budgets for 2015, need to therefore ponder issues such as:
- How low will Saudi Arabia allow the oil price to fall as it attempts to re-establish its political and military relationship with the US by getting rid of higher cost US shale-oil production? This argument rests on the notion that if the shale oil producers are forced to shut down, the US will need Saudi crude imports again, and so will need to maintain the political and military support that it has provided to the Kingdom since 1945.
- How bad will the geopolitics get? Vladimir Putin could cut Russian supplies of gas to Europe this winter, which are delivered via Ukraine. This could force oil prices a lot price higher as gas users in Europe are forced to switch to crude. Russia seems to be pursuing an end-game that has nothing to do with short term economic damage to its economy, and so can you afford to ignore the risk of gas supplies being curtailed? This truly terrifying article, from Gideon Rachman in the FT, took the blog back to its early adulthood in the 1980s, when the world was on the brink of nuclear catastrophe. “The darkest Polish scenario is also that Mr Putin might be tempted to go up to the nuclear brink by using conventionally armed missiles that could carry nuclear warheads,” writes Rachman.
Everybody is floundering for direction with no clear direction in sight.
For example, only last week, the blog asked how low prices would have to go before US shale-oil production would have to shut down. We were told $60-80 a barrel.
But now Citi, in a new report, argues that the floor price has fallen way below this level because of improvements in technology.
“We think what counts at this stage is half-cycle costs, which are in the significantly lower band of $37 to $45 a barrel,” writes the bank.
This kind of analysis could, of course, scare the Saudis into making the cutbacks that everyone hopes for, given that the accepted wisdom remains that they need crude at $90 a barrel to pay for their social programmes.
(We heard yesterday of another major Middle East oil producer which needs a minimum crude price of $74 a barrel to balance its budgets in order to fund its very extravagant welfare programmes).
But you need to also consider this about Saudi Arabia:
- It knows that it cannot repeat the 1981-1985 mistake of trying to stabilise the market by cutting production from 10 million barrels a day to 2 million barrels a day. All that happened was that it lost market share to fellow OPEC members.
Here is another thought: If Saudi Arabia, and the other big Middle East producers, gain enough market share after they have eventually driven higher cost producers out of business, might this be enough to pay for their social programmes? The price of oil might be $50 a barrel, or even lower, but because of greater volumes, revenues might be enough.
The panic out there right now is perhaps because of this: Some oil analysts and chemicals companies thought that there was long-term substance behind the relatively stable pricing created by all that central bank stimulus.
As a result, they do not know where to start in assessing real supply and demand as stimulus is withdrawn.
Does this include your company?
Between 2009-2014, the distortions created by the bankers included:
• Prices recovered sharply as central banks began printing cash on a low-cost model with low interest rates.
• Pension funds bought oil as a ‘store of value’, as the US Federal Reserve devalued the US dollar in order to boost exports.
• Investment banks created hype about supposed shortages, whilst hedge funds jumped in to follow the trend.
Meanwhile, as middle class incomes in countries such as the US stagnated, demand destruction was being caused by oil prices. And so this has led to higher fuel efficiency standards in vehicles and less miles being driven.
But we were told everything was fine on demand, despite the problems in the West.
We were told we didn’t have to worry because of:
1.) The rise of the “middle classes” in emerging markets.
2.) This was particularly so in China as a result of its “economic miracle”. China had the perfect economic growth model. This guaranteed that its demand for imported crude would continue to soar.
Now, though, of course, the Fed is ending its stimulus programme.
So too is China as it re-assembles its entire, deeply flawed economic growth model. In the long term, this will involve greater energy self-sufficiency, and greater conservation of energy, and so lower growth in oil imports.
Now we face the potential of a big supply overhang because oil producers bought into all this hype. This has led to big investments in new capacity.
As fellow blogger, Paul Hodges, quite brilliantly comments: “It takes only a microsecond to create a trade on a futures market [via high-frequency trading), but it takes at least 5 – 10 years to find new oilfields and bring them into production.”
Equally, we might face the geopolitical nightmare of the type highlighted above.
Oil prices at $50 a barrel, or even lower, in 2015? Or perhaps $150 a barrel? Take your pick.