What are we to make of this unexpected second fall in oil prices? Could we, in fact, be witnessing a fundamental shift in the energy industry? To answer either of these questions, consider why prices first fell in 2014 and why, at the time, analysts believed they would rebound by the middle of this year.
The initial collapse was widely attributed to three critical factors: an extraordinary surge in production from shale formations in the United States, continued high output by members of the Organization of the Petroleum Exporting Countries (OPEC) led by Saudi Arabia, and a slackening of demand from major consuming nations, especially China.
According to the Energy Information Administration of the Department of Energy, crude oil production in the United States took a leap from 5.6 million barrels per day in June 2011 to 8.7 million barrels in June 2014, a mind-boggling increase of 55% in just three years. The addition of so much new oil to global markets -- thanks in large part to the introduction of fracking technology in America's western energy fields -- occurred just as China's economy (and so its demand for oil) was slowing, undoubtedly provoking the initial price slide. Brent crude went from $114 to $84 per barrel, a drop of 36% between June and October 2014.
Historically, OPEC has responded to such declines by scaling back production by its member states, and so effectively shoring up prices. This time, however, the organization, which met in Vienna last November, elected to maintain production at current levels, ensuring a global oil glut. Not surprisingly, in the weeks after the meeting, Brent prices went into free fall, ending up at $55 per barrel on the last day of 2014.
Most industry analysts assumed that the Persian Gulf states, led by Saudi Arabia, were simply willing to absorb a temporary loss of income to force the collapse of U.S. shale operators and other emerging competitors, including tar sands operations in Canada and deep-offshore ventures in Africa and Brazil. A senior Saudi official seemed to confirm this in May, telling the Financial Times, "There is no doubt about it, the price fall of the last several months has deterred investors away from expensive oil including U.S. shale, deep offshore, and heavy oils."
Believing that the Saudi strategy had succeeded and noting signs of increasing energy demand in China, Europe, and the United States, many analysts concluded that prices would soon begin to rise again, as indeed they briefly did. It now appears, however, that these assumptions were off the mark. While numerous high-cost projects in Canada and Africa were delayed or cancelled, the U.S. shale industry has found ways to weather the downturn in prices. Some less-productive wells have indeed been abandoned, but drillers also developed techniques to extract more oil less expensively from their remaining wells and kept right on pumping. "We can't control commodity prices, but we can control the efficiency of our wells," said one operator in the Eagle Ford region of Texas. "The industry has taken this as a wake-up call to get more efficient or get out."
Responding to the challenge, the Saudis ramped up production, achieving a record 10.3 million barrels per day in May 2014. Other OPEC members similarly increased their output and, to the surprise of many, the Iraqi oil industry achieved unexpected production highs, despite the country's growing internal disorder. Meanwhile, with economic sanctions on Iran expected to ease in the wake of its nuclear deal with the U.S., China, France, Russia, England, and Germany, that country's energy industry is soon likely to begin gearing up to add to global supply in a significant way.
With ever more oil entering the market and a future seeded with yet more of the same, only an unlikely major boost in demand could halt a further price drop. Although American consumers are driving more and buying bigger vehicles in response to lower gas prices, Europe shows few signs of recovery from its present austerity moment, and China, following a catastrophic stock market contraction in June, is in no position to take up the slack. Put it all together and the prognosis seems inescapable: low oil prices for the foreseeable future.
A Whole New Ballgame?
Big Energy is doing its best to remain optimistic about the situation, believing a turnaround is inevitable. "Globally in the industry $130 billion of projects have been delayed, deferred, or cancelled," Bod Dudley, chief executive of BP, commented in June. "That's going to have an impact down the road."
But what if we've entered a new period in which supply just keeps expanding while demand fails to take off? For one thing, there's no evidence that the shale and fracking revolution that has turned the U.S. into "Saudi America" will collapse any time soon. Although some smaller operators may be driven out of business, those capable of embracing the newest cost-cutting technologies are likely to keep pumping out shale oil even in a low-price environment.
Meanwhile, there's Iran and Iraq to take into account. Those two countries are desperate for infusions of new income and possess some of the planet's largest reserves of untapped petroleum. Over the decades, both have been ravaged by war and sanctions, but their energy industries are now poised for significant growth. To the surprise of analysts, Iraqi production rose from 2.4 million barrels per day in 2010 to 4 million barrels this summer. Some experts are convinced that by 2020 total output, including from the country's semiautonomous Kurdistan region, could more than double to 9 million barrels. Of course, continued fighting in Iraq, which has already lost major cities in the north to the Islamic State and its new "caliphate," could quickly undermine such expectations. Still, through years of chaos, civil war, and insurgency, the Iraqi energy industry has proven remarkably resilient and adept first at sustaining and then boosting its output.
Iran's once mighty oil industry, crippled by fierce economic sanctions, has suffered from a lack of access to advanced Western drilling technology. At about 2.8 million barrels per day in 2014, its crude oil production remains far below levels experts believe would be easily attainable if modern technology were brought to bear. Once the Iran nuclear deal is approved -- by the Europeans, Russians, and Chinese, even if the U.S. Congress shoots it down -- and most sanctions lifted, Western companies are likely to flock back into the country, providing the necessary new oil technology and knowhow in return for access to its massive energy reserves. While this wouldn't happen overnight -- it takes time to restore a dilapidated energy infrastructure -- output could rise by one million barrels per day within a year, and considerably more after that.
All in all, then, global oil production remains on an upward trajectory. What, then, of demand? On this score, the situation in China will prove critical. That country has, after all, been the main source of new oil demand since the start of this century. According to BP, oil consumption in China rose from 6.7 million barrels per day in 2004 to 11.1 million barrels in 2014. As domestic production only amounts to about 4 million barrels per day, all of those additional barrels represented imported energy. If you want a major explanation for the pre-2014 rise in the price of oil, rapid Chinese growth -- and expectations that its spurt in consumption would continue into the indefinite future -- is it.
Woe, then, to the $100 barrel of oil, since that country's economy has been cooling off since 2014 and its growth is projected to fall below 7% this year, the lowest rate in decades. This means, in turn, less demand for extra oil. China's consumption rose only 300,000 barrels per day in 2014 and is expected to remain sluggish for years to come. "[T]he likelihood now is that import growth will be minimal for the next two or three years," energy expert Nick Butler of the Financial Times observed. "That in turn will compound and extend the existing surplus of supply over demand."
Finally, don't forget the Paris climate summit this December. Although no one yet knows what, if anything, it will accomplish, dozens of countries have already submitted preliminary plans for the steps they will pledge to take to reduce their carbon emissions. These include, for example, tax breaks and other incentives for those acquiring hybrid and electric-powered cars, along with increased taxes on oil and other forms of carbon consumption. Should such measures begin to kick in, demand for oil will take another hit and conceivably its use will actually drop years before supplies become scarce.
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