Oil Glut: Technology vs Dumping

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The price collapse in the oil market in June 2014 was neither sudden nor unpredictable. The imbalance of supply and demand formed over the years and it could have been predicted in advance. An overall decrease in the oil demand since the financial crisis of 2008, which plunged much of the world into the Great Recession, is hardly surprising. Mix it with the slowing Chinese economy and the growing presence on the market of the shale oil and you will get a good scenario for a cheap oil era. But these are, of course, only the most obvious reasons.

The oil market, like any other, is cyclical, so it is really hard to talk about the “unprecedented fall” in prices like many analysts say. Since the price shocks of the 1970s, similar corrections were observed in the market in 1986, 1998 and 2008. But the question that remains unanswered is: “when oil prices will return to the previous levels, and whether it happens at all?”

The price above $100 was artificial

When global oil production was nearly at the all-time high and then dropped to the seven-year low, the Organization of Petroleum Exporting Countries (OPEC) decided to keep production at maximum levels. This happened after it failed to reach an agreement with other countries on the coordinated production cuts. That move can keep oil prices at low levels until the demand will slump or the production of other major players in the market will decrease.

Some say Saudi Arabia decided not to reduce its oil production to be able to steer the prices in the right direction and reduce demand for renewable energy. But the answer may be different: OPEC is afraid of losing its influence. Perhaps the organization no longer believes in the comeback of the oil prices.

In fact, a member of the Saudi royal family and billionaire entrepreneur Prince Alwaleed bin Talal told USA Today that “the decision to not reduce production was prudent, smart and shrewd.” He also said that Saudi Arabia and OPEC does not plan to lower oil prices and the world will never see oil at 100 dollars per barrel again. “I said a year ago, the price of oil above $100 is artificial. It’s not correct,” stated Alwaleed bin Talal.

It is worth mentioning that the cost of extracting a barrel of oil in OPEC countries is one of the lowest in the world. Saudi Arabia and Kuwait, for example, can produce a barrel of oil for less than $10 per barrel, Iraq – at 10.7 per barrel. Obviously, the OPEC countries are able and eager to fight for their fair share of the oil market. In November, for example, Saudi Arabia has reduced the price of oil, that is being exported to Asia and the U.S. This happened along with the increasing competition among suppliers and at a time when Iraq and other Middle East countries were offering more discounts. According to Bloomberg, the discount from Saudi Arabia reached its highest level since 2012.

At the same time, Canada and russia continue to increase production and exports. moscow, despite its economic problems, manages to keep production high. Libya and Iran, that returned to the market after lifting of the sanctions, are ready to increase supply on the world market further. According to the director of National Iranian South Fields Oil Company Salbali Karimi, the production in central Iran can cost as low as $1-1.5 per barrel.

It is clear that OPEC can afford to put pressure on competitors and producers of shale oil in the U.S., whose production cost is much higher. However, even for the OPEC countries, the current level of oil prices is far from comfortable.

The Shale States of America

But squeezing competitors out of the market can be a challenging task. The booming oil production in the U.S. and the improved technologies reduce the impact that OPEC has on the market and, most likely, will keep oil prices low, says professor of Economics at Stanford University Frank Wolak.

Thanks to the shale energy revolution, U.S. oil production has increased from 5 million barrels per day in 2008 to 9.3 million barrels in 2015. And, despite the sharp fall in prices, the booming production in the country remains. Over the past six years, domestic oil production in the United States nearly doubled, significantly increasing the level of competition. Hence, the United States can be called one of the main reasons for the redistribution of the market. Oil from Saudi Arabia, Nigeria, and Algeria, which have recently been sold in the United States, began to compete for the Asian markets, and its producers are forced to cut prices.

BP chief economist Spencer Dale said that the game has changed dramatically because shale oil is flexible: its production is easy to stop and to recover. It’s as simple, says analyst, as the traditional production never dreamed of. Although few producing countries will be able to survive with the price of oil below $40 per barrel, the times when the oil price was above $100 per barrel are over, thinks Dale.

In his opinion, when oil prices cross the level of $50 per barrel, shale oil becomes profitable. Therefore, supply immediately increases that will prevent the growth of oil prices in the long run.

Furthermore, after the U.S. canceled a 40-year ban on the export of crude oil, American companies began to export oil to the already over-saturated international market. George Baker, head of Producers for American Crude Oil Exports, who fought for permission to export oil outside the U.S., said: “Now that we have leveled the playing field, the United States finally have an opportunity to compete and realize our nation’s full potential as a global energy superpower.”

Slowing appetites

Growth in European countries and countries with developing economies remain weak. The United States not only does not import oil anymore but began to export it. China, one of the largest consumers of oil, slowing its appetite.

According to the study of the International Energy Agency (IEA), the transformation of China into an energy-efficient nation has a great impact on the price of oil. For a long time, China has been one of the largest importers of oil, but in the last few months, its import was reduced substantially.

“Chinese demand will grow by 2.6% annually until 2020, which is only half of the increase in the consumption over the previous six years,” – says the IEA report. According to its experts, this reduction is one of the key changes that led to the global slowdown in the oil demand in recent years.

From 2009 to 2014 China accounted for 35% of the global growth in oil demand. According to the forecasts of the organization, this figure will drop to 25%.

Energy demand in China will depend on the ambitious goals of increasing energy efficiency and clean energy. “2013-2014 years have shown a marked increase in efficiency in China” – says the report.

And even a very conservative OPEC forecast shows that world supply will exceed the demand for years to come.

The energy of the sun

In the wake of increasing global energy consumption, especially in developing countries and a sharp decline in oil prices in the second half of 2015, the rise in the production of renewable energy continued.

For the first time in 40 years, the global carbon emissions related to the consumption of fossil fuels remained stable in terms of global growth. Production of electricity from renewable sources has increased significantly, and investments in this sector were ahead of net investments in the traditional power generation.

Thus, the share of renewable energy generation in the overall increase in 2014 exceeded 58%. In 2015 renewable energy accounted for about 27.7% of global generating capacity, which is enough to provide almost 23% of the world demand for electricity.

At the same time, the number of countries that have set targets for switching to renewable energy was steadily growing. At the beginning of 2015, at least 164 countries have set the task to switch to renewable energy. Some have even set a goal to reach the 100 percent mark.

The oil era is over?

The laws of commodity markets are simple: if supply exceeds demand, the price of any natural resource will decline until it regains equilibrium.

So, while there is a discrepancy between low demand and consistently high production, the cost of black gold will not grow. Perhaps this is why oil speculators are buying options that will be profitable only when oil prices will fall to $15 per barrel, writes Bloomberg.

“Excess production of oil will continue for much of 2016” – predicts global head of commodities research at Goldman Sachs Markets Jeffrey Currie. In his opinion, there is a risk that prices will fall to $20 per barrel. In any case, for now, futures suggest that oil prices in 2020 will not rise above 53 dollars per barrel.

The historical parallels may indicate that the recovery of oil prices can take at least ten years. But there are many arguments in favor of that the time of high oil prices will stay forever in the past.

In the 1980s, former oil minister of Saudi Arabia Ahmed Zaki Yamani said: “The Stone Age did not end for lack of stone, and the Oil Age will end long before the world runs out of oil.”

First published 2016

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