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$30 A Barrel Crude: Six Reasons Why It Will Happen Again

Business, China, Company Strategy, Economics, Environment, Oil & Gas, Sustainability, Technology
By John Richardson on 18-Aug-2015

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$30crudeBy John Richardson

IT WAS clear as early as January 2013 that US shale-oil production was on the rise. Back then I warned that this new supply threatened an oil-price correction.

If you stepped back from the consensus, it was also clear even earlier than 2013 – in 2011 – that there was something very troubling about China’s growth model.

So you could have seen a long time ago that there was a big risk of a surge in oil supply just as demand growth weakened.

The turning point for the demand side of the story occurred in November 2013, at the crucial Third Plenum meeting of China’s new leaders. They identified the long-standing faults in China’s debt-driven growth model and made it clear that they would launch major reforms in 2014.

But as these reforms gathered pace in H1 2014, and as the supply of oil continued to grow, it was the financial players that kept crude at artificially elevated levels. They continued to successfully spin the story that “supply and demand” fundamentals meant that the natural price of oil was around $100 a barrel.

When all of this unravelled with the collapse of crude in the second half of last year – on the realisation that China was, indeed, reforming and that global oil supply was way ahead of demand – a common assumption was that supply would soon be cut back. We were told that this would quickly bring markets back into balance and push crude back towards $100 a barrel.

But this ignored the fact that improvements in the efficiency of shale gas wells already gave us a pointer of what could happen in shale oil. And sure enough it has, as shale-oil production costs have all but collapsed. This thinking also failed to factor in the traditional role of debt in oversupplied industries – i.e. how it is better to run for a few dollars of returns on your debts than no dollars at all.

We also then had the Saudi Arabian decision to raise rather than reduce production in an effort to gain market share.

Unfortunately, though, next came the oil-price recovery from early February until the end of June. This was bad news for the chemicals industry because as recently as two months ago, some executives were thinking that the new, natural price was $60-80 a barrel.

It was obvious, though, that this recovery, right from its outset, was again to do with financial speculation rather than the real supply and demand fundamentals.

Nobody should therefore be surprised that oil prices on Monday fell to a new six-year low. This was another price reversal just waiting to happen.

Chemicals companies that missed last year’s collapse in crude will have incurred inventory losses. These losses will  have been compounded if they also bought into the $60-80 a barrel fallacy.

That’s the history. What’s the future?

For a change, one of the new consensuses on short-term oil pricing is actually helpful:

A CNBC survey found that a majority of analysts and traders now sees oil falling to $30 to $40 a barrel in the near term.

Longer term, into next year and beyond, here are six reasons why I believe crude is heading back to its historic average price of $30 a barrel:

  1. Vast oversupply is not only oil, but also in coal and gas.
  2. The return of real price discovery to oil markets as both the US and China wind back their economic stimulus programmes. The strengthening of the dollar is a symptom of this withdrawal of stimulus.
  3. The epicentre of today’s global macroeconomic concerns is, of course, China. But it will become ever-clearer that the global slowdown is also being driven by ageing populations in the West.
  4. The climate change debate is over in favour of the scientists who believe that the cause is human behaviour.
  5. “Doing more with less” will thus become the phrase that defines consumer behaviour and government policy. Fuel efficiency will continue to improve for both economic and environmental reasons. And for environmental reasons, oil will wherever possible be replaced by natural gas and renewables.
  6. Doing more with less will shape the thinking of state-owned and state-influenced oil producers in countries other than just Saudi Arabia. Production cut backs to maintain pricing will be rightly viewed as a waste of time. Instead, producers will pump as hard as they can for a long as they can. The unworkable alternative would be leave to oil reserves – i.e. national wealth – in the ground.