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Plunging oil prices challenge geopolitical, energy industry assumptions

Plunging oil prices challenge geopolitical, energy industry assumptions thumbnail

Global oil prices have fallen 25 percent since June, marking the return of oil-price fluctuation as a geopolitical wild card. Although oil prices have been relatively stable — about $100 a barrel — for the past five years, the historical pattern has seen high oil prices boost the strategic clout of producing countries by boosting government coffers, and falling prices have had the opposite effect.

The lower prices of the 1980s and ’90s, for example, weakened Russia’s geopolitical position, while the more recent increases have boosted Moscow’s ability to exert influence over former Soviet republics. Higher prices have enabled Venezuela’s leadership to strengthen opposition to U.S. influence throughout Latin America.

Fluctuations have had significant effects on economic growth. The fourfold increase imposed by the Organization of Petroleum Exporting Countries in 1973 to protest U.S. support for Israel during its war with Egypt and Syria that year boosted the revenues of producing countries while retarding economic growth elsewhere. Subsequent price drops slowed the economies of the producing countries while consumers elsewhere enjoyed an invigorating lift.

Lower prices tend to discourage investment in new projects, especially those involving large startup costs, such as deep-water and Arctic operations, thereby affecting long-term petroleum supply. The lower prices of the 1980s and ’90s caused a significant dip in major project development, resulting in supply shortfalls in the early 2000s and a price surge in 2005 through 2008. High prices, on the other hand, invite investment in such projects, resulting in the expansion of global supply.

The average $100 per barrel of recent years has encouraged the major energy companies to invest heavily in new projects, focusing in particular in such unconventional sources as Canada’s tar sands, U.S. shale, the offshore ocean floor and the Arctic. The new supply streams of brought online by these investments eased fears of peak oil and declining world output, and they shifted the center of gravity of world oil production from traditional suppliers in Africa and the Middle East to the shale and bitumen fields of North America.

But this surge in global production has collided with an unexpected slowing of global demand as a result of Europe’s economic downturn and decelerating growth in China. On Oct. 14, the International Energy Agency lowered its 2014 estimate of world demand by 200,000 barrels per day and its 2015 estimate by 300,000 barrels. Nevertheless, it said global supply was continuing to expand — the result of increased production in North America and the resumption of exports by Libya. The result, not surprisingly, has been a dive in prices.

This decline has altered the economic and geopolitical calculations of major producing countries, now forced to plan for decidedly lower returns from their oil exports. Falling oil prices will prove especially troubling for producers like Iran and Russia that rely on petroleum exports for the lion’s share of government revenue. Budgets in both countries are premised on $100-plus oil, and the falloff in state revenue will curtail international endeavors. Russia, for example, has been forced to reconsider plans for an expensive overhaul of its armed forces.

While every major producer is likely to suffer as a result of the price decline, those with lower production costs and budgetary expectations are expected to fare better than those with higher costs and expectations. Saudi Arabia, for example, is better positioned to weather the downturn because it enjoys relatively low production costs and can still finance most of its government obligations.

Some analysts speculate that there’s a geopolitical motive behind the Saudis’ rebuffing calls for OPEC to reduce the production quotas the cartel has traditionally used to keep prices higher. That’s because the lower prices are less harmful to Saudi Arabia than they are to Iran and Russia — countries that have angered Riyadh by helping prop up Bashar al-Assad’s regime in Syria and, in Iran’s case, for contesting Saudi influence throughout the Middle East.

Although the United States has emerged as a major producer, the impact of falling oil prices is, on balance, a positive one: While some energy firms in the U.S. could suffer from falling prices, the wider economy has benefited as lower energy costs boost an anemic economic recovery. The oil-price pressure on Russia bolsters U.S. efforts to change Moscow’s calculations in Ukraine by imposing economic sanctions.

The extent of these geopolitical shifts will depend on the duration of the price decline. Should oil prices stabilize in the coming weeks, the consequences could prove less than momentous; a bigger drop and longer decline would have farther-reaching effects. Whatever the outcome, the current dip has exposed weaknesses in the global oil enterprise that are not likely to disappear soon, even if prices rebound.

Ever since recovering from the financial crisis of 2008 and ’09, the major Western oil companies have based their long-term strategies on two key assumptions: First, that continuing economic growth in Asia and other emerging markets will generate an unquenchable thirst for petroleum products and, second, that mammoth investment in unconventional oil projects will be redeemed by unflagging increases in demand. Both assumptions now appear seriously flawed.

China’s growth has begun to sag, falling to 7.6 percent in the second quarter of 2014 — the lowest since the financial crisis and a marked retreat from the 9.5 percent of one year ago. President Xi Jinping has promised a vigorous drive to reform the economy and stimulate growth, but few analysts expect any significant results in the next few years. Exuberant growth in Africa and a few other developing areas may help compensate for the sluggishness in Asia, but is unlikely to generate the ever-expanding demand once anticipated by oil company strategists.

The other pillar of the oil industry strategy — ample returns on costly unconventional projects — is showing signs of strain. Endeavors such as drilling in the Arctic and exploiting Canada’s tar sands are profitable only at prices of $90 a barrel or higher. The extraction of oil from shale might remain profitable with prices hovering above $80, but some high-cost producers could be forced to suspend operations. And if prices fall much below $80, the prospects for many unconventional projects could prove dismal.

Should prices climb back above $100 per barrel, many of these undertakings could prove attractive again. But higher prices are likely to inhibit economic growth — and without growth, demand may not rebound. Low-cost producers like Saudi Arabia might prosper in such an environment, but high-cost producers like Canada and the U.S. may not fare so well.

Under these circumstances, the major oil companies may conclude that significant alterations are needed in their long-term strategies for success. What form those could take is not immediately evident, but it is this prospect, more than any other, that is likely to prove the most lasting consequence of the current dip in prices.


19 Comments on "Plunging oil prices challenge geopolitical, energy industry assumptions"

  1. Davy on Thu, 23rd Oct 2014 7:01 am 

    We are damned if we do damned if we don’t with oil prices. The Goldilocks range to prevent economic contraction is steadily compressing. This has left us with a lit fuse on the collapse time bomb.

  2. Jared on Thu, 23rd Oct 2014 7:05 am 

    “But higher prices are likely to inhibit economic growth — and without growth, demand may not rebound. ”

    Talk about burying the lead. Finally, at the second-to-last paragraph, they get to the crux of the entire issue. And they still hedge with the limp qualifier “likely.” … High prices WILL inhibit growth, just as they have since the price spikes began 12 years ago. … This is a trade war amid the imminent decline of conventional production.

  3. rockman on Thu, 23rd Oct 2014 9:15 am 

    “The lower prices of the 1980s and ’90s,…”. Adjusted for inflation oil priced at $80/bbl (adjusted for inflation) today is still 290% higher than the average price during the 90’s. Oil exporters may be pulling in less revenue now than they were a year ago but they are still making much more than the historical average.

  4. paulo1 on Thu, 23rd Oct 2014 10:00 am 

    Good article, but this statement is not true: ” Canada’s tar sands are profitable only at prices of $90 a barrel or higher.”

    Some are profitable at $35/bbl and some require higher prices. It is the old 5 W story. Who, what, where, why, when.


  5. Kenz300 on Thu, 23rd Oct 2014 10:09 am 

    Oil Companies need change their business models and become “Energy Companies” by embracing safer, cleaner and cheaper alternative energy sources.

    High cost shale, tar sands and deep water drilling will prove to be too costly.


    New Biofuels Facility Converts Plant Waste To Ethanol, Is 90 Percent Cleaner Than Gasoline

  6. GregT on Thu, 23rd Oct 2014 10:17 am 

    “China’s growth has begun to sag, falling to 7.6 percent in the second quarter of 2014 — the lowest since the financial crisis and a marked retreat from the 9.5 percent of one year ago.”

    “The greatest shortcoming of the human race is our inability to understand the exponential function.” Albert Bartlett

    China has close to 20% of the world’s population. If China’s growth is maintained at 7.6%, her economy will double in less than a decade. So much for the supposed ‘oil glut’.

  7. JuanP on Thu, 23rd Oct 2014 10:18 am 

    “Higher prices have enabled Venezuela’s leadership to strengthen opposition to U.S. influence throughout Latin America.”
    This is a load of crap. The only Latin Americans that give a crap about what happens in Venezuela or what Venezuelans think are the Venezuelans themselves.
    How much do you care what Nicaraguans think? Same thing. Venezuela is not and has never been a Latin American leader in any significant way. People in my country, Uruguay couldn’t care less what Venezuelans think or do. And the same goes for all other Latin Americans. I interact with people from all over there daily.
    The problems that Latin Americans have with the USA are a consequence of America’s selfish, counterproductive actions in Latin America going on two centuries now.
    To blame Venezuela for Latin America’s feelings towards the US government is outrageous!

  8. JuanP on Thu, 23rd Oct 2014 10:28 am 

    GregT “China has close to 20% of the world’s population. If China’s growth is maintained at 7.6%, her economy will double in less than a decade.”
    China grew more than 10% a year for over 30 years, starting in 1978 with Deng Xiaoping’s policies. It grew at a faster rate and for a longer time period than any other economy in human history.
    I can’t understand people who think China’s strong growth can continue. It is completely unsustainable.
    China’s rate of growth has been contracting steadily for years now, and I expect this trend to continue all the way to no growth and then contraction in the years ahead.
    Albert Bartlett was so right.

  9. Plantagenet on Thu, 23rd Oct 2014 10:55 am 

    Venezuela props up Cuba with oil subsidies, and influences leftist regimes in Bolivia and Brazil. Petrostates are influential because they have oil and money even if, like Venezuela, the regimes running them are so incompetent they have to institute food rationing

  10. Davy on Thu, 23rd Oct 2014 10:58 am 

    China’s real growth rate is thought to be around 3% when reality testing is applied. My thoughts are it is actually negative considering the inconsistencies of excessive growth in relation to healthy growth. The same is true of the US to a lesser extent. Do you call urban sprawl growth or a waste of time.

  11. JuanP on Thu, 23rd Oct 2014 11:40 am 

    Plant, Cuba will take the cheaper oil and be grateful for it, but won’t allow the Venezuelans to lead them, they think Venezuelans are foolish to sell their oil at a discount. I know, I am surrounded by one million of them.
    Venezuela doesn’t lead Brazil, things are actually closer to the opposite. Brazil is the only real Latin American leader. Which is very easy to understand if you look at a map.
    And while Venezuela and Bolivia are in friendly terms, Bolivians set their own course, president Maduro doesn’t lead President Morales in any way. They just help and support each other as much as they can.
    I’l go to what I know best again, my country. Uruguay buys oil from Venezuela on credit without interest and pays for less than it purchases so the loan balance keeps growing. This has been going on for many years. Yet, Uruguayans don’t see Venezuelans as leaders or are led by Venezuelans in any way. We think that they are giving as something for nothing because they will never have any influence over my country’s policies.

  12. shortonoil on Thu, 23rd Oct 2014 2:25 pm 

    The WSJ said, in great exaltation, this morning that oil prices were going to rise because SA announced that they were going to cut production. SA did cut production, and it was by 326,000 b/d. WTI prices at 3:00 PM had risen $1.20/b. At that rate if SA cut production by 1 m/d prices would rise $3.65/barrel. The world has reached the maximum price that the economy can sustain, and no one could afford to cut production enough to bring it back to $100.

    We are approaching the end of the oil age, and production costs are overwhelming the markets ability to absorb them. This was predicted by our model.

  13. rockman on Thu, 23rd Oct 2014 2:59 pm 

    shorty – So given that $80-$85 per bbl may be the current balanced dynamic the next question might be for how long. Of course that may depend more on economic vitality then geology. Have y’all generated any time lines for significant changes going forward

  14. Kenz300 on Thu, 23rd Oct 2014 5:20 pm 

    Growth in China will continue to slow………

    That is not necessarily bad……… you can not grow at 9% FOREVER.

    Unless the Chinese government pumps in large amounts of stimulus, China’s growth will slow to sub 7% next year and decline more in the future.

    They have seen what uncontrolled growth has done to their environment in terms of air, water and land pollution. Wearing a mask because you are afraid of the dirty air is no way to live. The government is starting to address the problems and is embracing alternative energy sources and electric vehicles.

  15. shortonoil on Thu, 23rd Oct 2014 5:56 pm 

    “Of course that may depend more on economic vitality then geology.”

    I think $90/b oil would be a safer bet for the short term; not much chance of any extended jump over that. So how many ongoing projects are going to get canceled, and how much drilling is going to be stopped in shale, and other high production cost areas? Another unrelated analysis estimates that demand will fall by 1.9 mb/d next year. So it looks like we are on a 2.5 to 3% down slope from here on out. Our 2016 Peak for all liquids looks to be a little late.

    Unless someone can convince SA to commit suicide, and cut their production by 2 to 3 mb/d we aren’t going to see any rapid improvement in price. I think they already know it wouldn’t do any good long term anyway; outside of collapsing the already teetering world economy.

    Peak everything is here, and we can stop the demand/ supply battle. Demand won!

  16. GregT on Fri, 24th Oct 2014 9:59 am 


    If you re-read what I wrote; ” ‘IF’ China …….”.

    I have no belief that Chinese growth (or anyone else’s) can be maintained, and in many respects that growth, in reality, has already ended. I was merely attempting to point out how ridiculous the never ending growth mantra has become.

    Albert Bartlett was correct, of course, our failure to understand the exponential function will be our greatest shortcoming. It is already very apparent, and it will lead to our specie’s demise.

    The economists got it all wrong, yet many still fall for the growth mantra. Never ending growth was never anything more than a fairy-tale.

  17. JuanP on Fri, 24th Oct 2014 11:42 am 

    Greg, I got you right the first time. I was agreeing with you. The criticism was not addressed at you. I just made it part of the same comment. 😉

  18. JuanP on Fri, 24th Oct 2014 11:46 am 

    Greg, my comment wasn’t clear. My criticism was towards the people that don’t get what you were saying, not you. You’ll have to forgive me, my mind is dazed and confused!

  19. Kenz300 on Sun, 26th Oct 2014 11:54 am 

    Lower oil prices will cause high cost energy projects will be reevaluated. Some will be delayed or cancelled. Some companies that got over extended will be forced into bankruptcy.

    A short term drop in oil prices will be a boost to the global economy at the expense of the higher cost producers like Iran, Russia, tar sands and shale developers.

    In any case a drop in oil prices will be for the short term. That may be enough to slow down the competition and that would make the Saudi’s happy.

    China and india may not be growing as fast as they have in the recent past but they are still growing. Demand will continue to rise, only slower than previously predicted.

    China is reviewing their use of fossil fuels. The high pollution levels have finally got the attention of the politicians. China is investing heavily in wind, solar and now geothermal power. They are also subsidizing investments in electric vehicles and biofuels. Their efforts will begin to slow the growth of fossil fuels but fossil fuel use is still growing.

    China Turns to Geothermal Energy To Tackle Carbon Emissions

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