By John Richardson
I HAVE LONG been intrigued by the theory in quantum physics that electrons behave differently when they are observed as opposed to when they are not being observed.
Data is quite similar in that it can be made to behave differently through conscious or unconscious confirmation bias. Two people can look at the same set of numbers and come up with entirely different conclusions.
So it goes with oil-price data. There is a body of conventional opinion firmly welded to the idea that today’s low prices are an anomaly that will be corrected by laws equivalent in their immutability to the laws of nature – the laws of supply and demand.
Many of my contacts argue that supply cannot be enough to meet to demand as today’s prices so prices must go up. This view is built on the assumption that low capital cost shale oil production is not big enough to meet global demand.
Now that US shale- oil production has collapsed a significant amount of supply has been removed. This requires the big conventional oil fields to take up the strain of meeting demand.
These fields require lots of reinvestment capital and can therefore only take the strain if prices are much higher than they are today. As investment in the big fields falls on today’s low prices, demand will exceed supply, prices will increase, and the required investment will come back.
But I do not see the laws of supply and demand as being anything like the laws of nature. History teaches us that the laws have evolved in line with technological, political and societal changes. For example, at one stage in the early 19th Century, the supply of horse manure way exceeded the demand for manure as fertiliser. But then the internal combustion engine happened.
I can see oil prices rising for short periods of time because of supply cutbacks. But high prices will further damage demand that was already on a long-term steep decline long before COVID-19.
This was the result of ageing populations (when you get older you travel less and need far fewer things made from oil). Decarbonisation was gathering pace as a result of another conventional opinion that on this occasion is correct: Human activity is behind potentially devastating changes in our climate.
COVID-19 has of course made the world a lot poorer. The hit to the global economy is at least as big, probably much bigger, than the Global Depression, as an IMF report highlighted earlier this week. This will make temporary spikes in oil prices, resulting from a fall in investment in big oil fields, even less sustainable as people travel even less and buy even fewer things made from oil.
The COVID-19 tragedy will increase the pace of decarbonisation, leading to the world in 2025 looking like this:
The pandemic has increased the pace of decarbonisation as the outbreak has been linked with climate change. People are overwhelmingly of the view that we had been playing around with nature in ways we could not control. A major wave of new environmental legislation is in place as we push towards a green global economy.
How will the oil industry respond as crude demand sharply declines? It will be a battle for market share. Production costs will set the price of oil rather than reinvestment costs and the price required to balance national budgets.
According to the above IEA chart, 85% of global oil production can be produced at $15 a barrel. Producers will have no choice but to charge prices for oil close to this level because of the changes in the laws of supply and demand.
This threatens to devastate the economies of the oil producers because prices will not be high enough to meet the needs of national spending on healthcare and pensions etc. But the big producers can win more volume as the higher-cost producers disappear.
If the oil producers also get with the New Green Deal and decarbonise their economies, they will create many millions of new jobs whilst also slowing down climate change. This will save them many billions of dollars on infrastructure spending through fewer droughts and floods, provided of course the rest of the world also gets with the New Green Deal.
Conventional opinion on oil prices will soon shift towards my scenario of long-term prices of $30 a barrel or lower. The sooner the better because we can then as a petrochemicals industry start making the adjustments for a very different but still very profitable future. I will detail the opportunities the energy transformation presents for our industry in later posts.