Oil Prices: The Roller Coaster to Nowhere

When Amory Lovins puts out a new essay, it’s usually worth a read.

Amory Lovins for Rocky Mountain Institute:

Oil prices tend to rise with instability in major exporters — Persian Gulf, Nigeria, Venezuela, Russia — though diversified supplies, suppliers, and delivery routes have made markets more placid. Strong economic growth also tends to raise prices — until they get high enough to dampen or reverse the economic growth. Conversely, oil prices fall when major exporters do what John D. Rockefeller used to do regularly: “sweat the market” with oversupply to bankrupt high-cost producers and thus raise one’s own monopoly rents.

Instability and surplus are both occurring today, but surplus is proving more important. The world market is glutted with several million extra barrels per day (Mbbl/d), mainly from fracked U.S. oil and Canadian tar sands. The U.S. is now the world’s largest oil producer, with output at a 31-year high.

Late last year, the Saudis and allies announced they wouldn’t cut output to rebalance the market as they had in the past. Why should they? They’d simply give up market share to higher-cost producers. And the Saudis didn’t cause the imbalance; North Americans and other non-OPEC members did.

Until recently, only the Saudis (and to a lesser extent their Gulf allies) had big surplus production capacity, and at the world’s lowest cost. Saudi oil costs about one-tenth as much to extract as fracked U.S. oil or Alberta tar sands need to break even. Now an added reality is roiling markets: only the Saudis have enough cash to weather a prolonged price drop. While Iran, Iraq, Venezuela, Russia, and Nigeria are financially stressed, the Saudis claim 2.5 Mbbl/d spare oil capacity and $0.7–0.9 trillion of monetary reserves — enough to sustain several years of $50 oil and keep funding their $40-billion renewable-power program (meant to save oil for export).

Here, Michael Liebrich of Bloomberg New Energy Finance discusses the cheapest solar energy in the world.

Lovins continues:

Against that backdrop, competitors are fish in a barrel. The biggest oil companies’ capital expenditures quintupled since 2000 but their production barely budged. That’s a seriously diminishing return per barrel at any price, let alone lower prices that undermine profitability. When oil prices suddenly fell nearly 60 percent in seven months, firms frantically cut costs and axed massive Arctic, deepwater, and other high-cost projects. In what analysts Wood Mackenzie call “the biggest threat to oil and gas industry earnings and financial solidity since the financial crash of 2008,” investments may fall by $200+ billion this year.

Tar-sand and fracking operators will be severely tested: frackers in the oil-rich Bakken are producing a gusher of red ink despite falling service costs and continuing technological improvement. Even those North American operators who survive the downturn may lose skittish investors to safer pursuits — such as renewable power, whose lower risks now attract capital several percentage points cheaper than utilities get. It was, after all, the former Saudi oil minister, Sheikh Ahmed Zaki Yamani, who famously 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.”

Rich countries’ oil use peaked in 2005. Developing countries’ oil demand is moderating. Start with mobility, which uses three-fifths of world oil. Strong auto efficiency standards already widely adopted (including China and India) will keep gasoline demand subdued or even shrinking, despite sharply lower fuel prices.

U.S. driving has been falling since 2007 and hasn’t rebounded with nearly halved gasoline prices. Bloomberg New Energy Finance (BNEF) notes that in the past 10 years, Americans’ driving fell 10 percent below trend, while in the past 13, their vehicles got 29 percent more efficient. Result: innumerable negabarrels.

Thus, what’s normally described as an oil supply surplus is at least equally a shortfall in forecast demand. Suppliers invested to meet demand that’s not there. The resulting oversupply pushes prices down relentlessly. This deflation could be quite persistent. As the International Energy Agency said on 16 January 2015, “It is clear that the market is undergoing a historic shift. OPEC’s embrace of market forces…is a game changer… Oil’s place in the global energy mix is also transforming… [T]he next few years could…prove a period of reckoning for a market and an industry that, through the course of their 150-year history, have had to periodically reinvent themselves.”

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Frackers, sweating on the junk-bond treadmill to keep drilling to sustain cashflow, are praying oil prices will rebound swiftly. Their prayers may go unanswered. Drilling has fallen in peripheral areas but continues in the richest core areas, such as the North American Bakken, keeping output high and prices low. Meanwhile, inventories of cheaper oil are brimming — at their highest U.S. level since 1931. These huge stockpiles may require even bigger supply cuts to rebalance the market. That prolongation could prove very painful for frackers and their investors, and fatal for tar-sands operators, with oil prices remaining low enough to deter new fracking. The simplest way to raise prices would be for oil giants to stop mining their money-losing Alberta tar sands whose oil the Keystone XL pipeline was supposed to carry.

Cheaper oil’s basic dynamic could become self-reinforcing. It defers development of costlier, often higher-carbon resources. This buys more time for efficiency and renewables to get bigger, hence cheaper, hence bigger, hence cheaper — even as cheaper oil seems to superficially compete with them — further softening demand and requiring even bigger supply cuts that take still longer. The next stage of the mobility revolution begins to emerge too, replacing many private autos with shareable and even autonomous ones powered by electricity, not gasoline. All the while, oil demand drops further, deepening drillers’ distress.
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What does the renewable energy revolution have to do with cheaper oil? Almost nothing, and that’s the point. Less than five percent of the world’s electricity and less than one percent of U.S. electricity is made from oil, so oil and renewable power scarcely compete. Electricity’s competitive landscape is virtually oil-free except on some islands and such other remote sites as mines and military bases where imported diesel and heavy fuel oil power the generators. On the contrary, cheaper oil means less fracked oil, less byproduct natural gas, higher gas prices, hence even more-competitive wind and solar power. And as batteries get cheaper, electric cars will increasingly threaten oil’s core mobility market.

Cheaper gasoline may admittedly stretch the payback of electric cars, but residential electricity averaging 13¢/kWh runs a Nissan LEAF at less than half the cost per mile of $2 gasoline in a typical 25-mpg car. BNEF estimates that 37-percent-cheaper gasoline could cut electric vehicles’ share of the 2020 U.S. auto fleet from 9 percent to 6 percent. Yet electric autos continue to get cheaper while customer adoption grows — Norway’s strong “feebate” boosted their 2014 market share to 12.5 percent.

Michael Liebrich on the Future of Utilities:

Lovins:

BNEF Advisory Board Chairman Michael Liebreich said: “The orthodox view of unlimited oil demand growth simply does not hold in a world of superefficient engines, electric vehicles, desperate air pollution problems, and action on climate. The U.S. economy has grown by 8.9 percent since 2007, while demand for finished petroleum products has dropped by 10.5 percent. Improvements in gas mileage and reduction in miles driven per person have had more impact on cutting U.S. oil imports than unconventional production. The story should not be how falling oil prices will impact the shift to clean energy, it should be how the shift to clean energy is impacting the oil price.”