Crude Oil: How To Avoid A 2015 Budget Disaster

By John Richardson

IF I knew the outcome of today’s crucial OPEC meeting in Vienna well, of course, I wouldn’t have to write this blog post to make a living.

But what I do know is that oil markets, now that the Fed stimulus is being withdrawn, are beginning to function far better than they have done since 2008. Supply and demand of crude itself are re-asserting themselves as the main price drivers rather than financial speculation.

Sadly, though, most people I speak to still don’t seem to get it.

As an example, when I was in Singapore two weeks ago for a series of ICIS conferences, I was disappointed at the number of people who thought that prices in the region of $100 crude were the real “New Normal”, thanks to the budget requirements of OPEC members and the strength of China’s economy.

This worries me as, of course, many of the delegates worked for chemicals companies and will have been involved in drawing up budgets for 2015. Anybody who has assumed average prices anywhere near $100 for next year has taken an enormous risk.

Sure, temporarily, prices might return to close to that level because of a decision to make major production cuts at the OPEC meeting today.

Equally, of course, geopolitics could cause a temporary spike in prices back to around their levels of the last six-and-a-half years.

But, as I have discussed before, but feel the urgent need to stress again: Be careful what you wish for.

A much longer term, and therefore more useful view of history, tells us this story:

BPoil

The above slide is from the BP World Energy Review 2013.

It shows that in inflation adjusted terms (the lighter green top line), recent crude oil prices were almost at their highest level since 1861.

You might, of course, contend that history has changed as the world is a much-richer place now than it was in 1861.

But how much richer?

Baseofthepyramid

The above chart shows that as of 2012, 4 billion of the world’s 7.3 billion people were earning a maximum of $5 a day.

Take away the illusory “wealth effect” of excessively easy credit in the West, and most importantly in China, and we are back to the price that most people on this planet can afford to pay for all the things made from crude oil.

One thing should at least have been accepted by now: The days of too-easy credit are over for good in China.

Governments across the developing world have long realised that the real affordability of oil for most of their populations is very low – hence, programmes to heavily subsidise the cost of fuel.

The great news is that the recent lower oil prices have given India and Indonesia the political leeway to wind back these hugely expensive, very economically damaging, subsidy schemes.

Provided that oil prices at least stay where they are today – and, hopefully, fall even further – the governments of both countries should be able to resist the political pressure to reinstate the subsidies. Much more money can then be spent on education, sanitation, healthcare and infrastructure.  This would enable hundreds more millions of people to escape from extreme poverty.

Morally as well as economically, therefore – and I don’t think that the use of “morally” is overstating the case at all – we should all be wishing that oil prices stay a great deal below $100 a barrel.

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