The economics of oil have changed. Some businesses will go
bust, but the market will be healthier
THE official charter of OPEC states that the group’s goal is “the
stabilisation of prices in international oil markets”. It has not been doing a
very good job. In June the price of a barrel of oil, then almost $115, began to
slide; it now stands close to $70.
This near-40% plunge is thanks partly to the sluggish world
economy, which is consuming less oil than markets had anticipated, and partly
to OPEC itself, which has produced more than markets expected. But the main
culprits are the oilmen of North Dakota and Texas. Over the past four years, as
the price hovered around $110 a barrel, they have set about extracting oil from
shale formations previously considered unviable. Their manic drilling—they have
completed perhaps 20,000 new wells since 2010, more than ten times Saudi Arabia’s
tally—has boosted America’s oil production by a third, to nearly 9m barrels a
day (b/d). That is just 1m b/d short of Saudi Arabia’s output. The contest
between the shalemen and the sheikhs has tipped the world from a shortage of
oil to a surplus.
Fuel
injection
Cheaper
oil should act like a shot of adrenalin to global growth. A $40 price cut
shifts some $1.3 trillion from producers to consumers. The typical American
motorist, who spent $3,000 in 2013 at the pumps, might be $800 a year better
off—equivalent to a 2% pay rise. Big importing countries such as the euro area,
India, Japan and Turkey are enjoying especially big windfalls. Since this money
is likely to be spent rather than stashed in a sovereign-wealth fund, global
GDP should rise. The falling oil price will reduce already-low inflation still
further, and so may encourage central bankers towards looser monetary policy.
The Federal Reserve will put off raising interest rates for longer; the
European Central Bank will act more boldly to ward off deflation by buying
sovereign bonds.
There
will, of course, be losers (see article). Oil-producing countries whose
budgets depend on high prices are in particular trouble. The rouble tumbled
this week as Russia’s prospects darkened further. Nigeria has been forced to
raise interest rates and devalue the naira. Venezuela looks ever closer to
defaulting on its debt. The spectre of defaults and the speed and scale of the
price plunge have unnerved financial markets. But the overall economic effect
of cheaper oil is clearly positive.
Just
how positive will depend on how long the price stays low. That is the subject
of a continuing tussle between OPEC and the shale-drillers. Several members of
the cartel want it to cut its output, in the hope of pushing the price back up
again. But Saudi Arabia, in particular, seems mindful of the experience of the
1970s, when a big leap in the price prompted huge investments in new fields,
leading to a decade-long glut. Instead, the Saudis seem to be pushing a
different tactic: let the price fall and put high-cost producers out of
business. That should soon crimp supply, causing prices to rise.
There
are signs that such a shake-out is already under way. The share prices of firms
that specialise in shale oil have been swooning. Many of them are up to their
derricks in debt. Even before the oil price started falling, most were
investing more in new wells than they were making from their existing ones.
With their revenues now dropping fast, they will find themselves overstretched.
A rash of bankruptcies is likely. That, in turn, would bespatter shale oil’s
reputation among investors. Even survivors may find the markets closed for some
time, forcing them to rein in their expenditure to match the cash they generate
from selling oil. Since shale-oil wells are short-lived (output can fall by
60-70% in the first year), any slowdown in investment will quickly translate into
falling production.
This
shake-out will be painful. But in the long run the shale industry’s future
seems assured. Fracking, in which a mixture of water, sand and chemicals is
injected into shale formations to release oil, is a relatively young technology,
and it is still making big gains in efficiency. IHS, a research firm, reckons
the cost of a typical project has fallen from $70 per barrel produced to $57 in
the past year, as oilmen have learned how to drill wells faster and to extract
more oil from each one.
The
firms that weather the current storm will have masses more shale to exploit.
Drilling is just beginning (and may now be cut back) in the Niobrara formation
in Colorado, for example, and the Mississippian Lime along the border between
Oklahoma and Kansas. Nor need shale oil be a uniquely American phenomenon:
there is similar geology all around the world, from China to the Czech
Republic. Although no other country has quite the same combination of eager
investors, experienced oilmen and pliable bureaucrats, the riches on offer must
eventually induce shale-oil exploration elsewhere.
Most
important of all, investments in shale oil come in conveniently small
increments. The big conventional oilfields that have not yet been tapped tend
to be in inaccessible spots, deep below the ocean, high in the Arctic, or both.
America’s Exxon Mobil and Russia’s Rosneft recently spent two months and $700m
drilling a single well in the Kara Sea, north of Siberia. Although they found
oil, developing it will take years and cost billions. By contrast, a shale-oil
well can be drilled in as little as a week, at a cost of $1.5m. The shale firms
know where the shale deposits are and it is pretty easy to hire new rigs; the
only question is how many wells to drill. The whole business becomes a bit more
like manufacturing drinks: whenever the world is thirsty, you crank up the
bottling plant.
Sheikh
out
So
the economics of oil have changed. The market will still be subject to
political shocks: war in the Middle East or the overdue implosion of Vladimir
Putin’s kleptocracy would send the price soaring. But, absent such an event,
the oil price should be less vulnerable to shocks or manipulation. Even if the
3m extra b/d that the United States now pumps out is a tiny fraction of the 90m
the world consumes, America’s shale is a genuine rival to Saudi Arabia as the
world’s marginal producer. That should reduce the volatility not just of the
oil price but also of the world economy. Oil and finance have proved themselves
the only two industries able to tip the world into recession. At least one of
them should in future be a bit more stable. The Economist
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