While pension holders and investors watched aghast as billions of pounds were lost to market gyrations, a fossil-fuel glut and a slowing global economy have driven the oil price down to a level that could save the world $1.8bn a day on fuel costs. If this is some consolation for households everywhere after last week’s hit on stock market wealth, it means pain for the Opec cartel, composed mainly of Middle East producers.
Opec’s 12-member group has largely controlled the global price of crude oil for the past 40 years, but the US’s discovery of shale oil and gas has dramatically shifted the balance of power, to the apparent benefit of consumers and the discomfort of petrostates from Venezuela to Russia.
The price of oil has plummeted by more than a quarter since June but will Opec, which holds 60% of the world’s reserves and 30% of supplies, cut its own production to try to lift prices? Or will the cartel allow a further slide from the current price – in the mid-$80s per barrel – in the hope of making it impossible for US drillers to make a profit from their wells, and so driving them out of business?
Saudi Arabia – Opec powerhouse and traditional ally of Washington – and other rich Gulf nations have been building up their cash reserves and have shown themselves willing to slash prices in a bid to retain market share in China and the rest of Asia.
The US, the world’s biggest oil consumer, has relied in the past on Saudi to keep Opec price rises relatively low. But now it has the complicating factor of protecting its own huge shale industry.
Even US oil producers see the political benefits of abundant shale resources and the resultant downward pressure on prices. Rex Tillerson, chief executive of Exxon Mobil, the biggest US oil company, said recently that his country had now entered a “new era of energy abundance” – meaning it is no longer dependent on the politically unstable Middle East.
So there will be understandable tension next month when the ruling Opec body meets in Vienna and its member states fight over what to do. The cartel would like to reassert its authority over oil prices but some producing countries, such as Saudi, can withstand lower crude values for much longer than others, and the relative costs of production vary wildly between nations.
Since the Arab spring, many countries in the Middle East have hugely increased their public spending in response to growing dissent over unemployment and high prices. A lower oil price endangers this.
Bijan Zanganeh, the Iranian energy minister, has already put in a plea for a production cut: limiting supply would raise prices and increase national income from fossil fuels. He knows that his country’s higher-than-average production costs, plus an economy undermined by years of sanctions, mean it would come off badly in any oil war with the US.
Venezuela and Angola are also known to be keen for the cartel to push prices up again with production cuts.
In Vienna, Opec delegates will debate the merits of reducing production quotas for member states in an attempt to drive up the international oil price, or keeping prices low in a game of chicken with the US that could force cutbacks in the shale lands of Texas and Pennsylvania.
Recent history offers an incentive for Opec brinkmanship. In 2012, a slump in the price of US natural gas led to major changes. Exploration and production companies had rushed into shale gas drilling, only to be forced into a huge retreat when the ensuing fossil-fuel glut saw prices fall from $11 per million British thermal units in 2008 to below $3. Even the largest oil companies, such as Exxon Mobil and Shell, were badly burned by their shale gas assets plunging in value.
While Opec wrestles with its internal politics, the US president is mulling a gambit of his own. Barack Obama is now considering whether to lift the restriction on crude exports imposed in the 1970s, a move that could put further pressure on Opec producers by lowering prices but also turn the screws on Russia, which is in Washington’s bad books over Ukraine. One of the many conspiracy theories currently doing the rounds over the oil price suggests the US and Saudi Arabia are acting in concert in a bid to hurt Iran and Russia.
Deutsche Bank analysts have claimed that US oil output stands to be undermined as long as the price is under $90 a barrel. But Ed Morse, global head of commodities research at Citigroup, disagrees. “Production is getting less costly every year and break-even costs are plummeting to much lower levels than commonly believed, certainly lower than $75,” he argued in a blog.
Over recent years drilling has been going on in US national parks, back gardens and even underneath aircraft runways, and local production is at its highest in 30 years. The latest survey from global oil services company Baker Hughes reports that the number of oil rigs in North America has reached its highest ever, at just over 1,600.
But it is not just the enormous increase in US production over the past couple of years – it grew by 15% in 2013 alone – that has caused the glut. It is not just more supply that has tipped the balance. The world is seeing much lower than anticipated demand for fossil fuels because countries from Europe to Asia are struggling to return to the economic growth levels of the pre-crash era.
And moreover many countries, Britain, Germany and Japan among them, have also been working hard to reduce their demand for oil by becoming more energy efficient.
Meanwhile traders have also started to unwind the effects of the geopolitical risk that was attached to oil amid fears that Islamic State advances in Syria and Iraq could lead to supply disruption in the wider Middle East. Concern that the standoff between the west and Russia over the Ukraine could lead Vladimir Putin to restrict oil and gas exports to Europe has also subsided.
But Russia is at risk itself in this low-price environment, because half of the state’s revenues come from oil and gas. The Moscow stock market has dropped by more than 20% since the summer and the rouble has fallen by a similar amount this year against the dollar. Russia’s central bank is said to be working on a shock scenario of oil prices hitting $60.
It is no wonder, therefore, that market sentiment towards oil has changed. There has been an wholesale rewriting of price forecasts across Wall Street and the City of London. Credit Suisse has reduced its forecast for Brent to $93 for 2016 and $88 for 2017.
This compares with a price of oil which averaged $111 in both 2011 and 2012 and which only dipped to $108 last year. A continued trough around the current level of mid-$80 would hurt the producing countries but clearly help the consuming nations.
This is the flipside to last week’s stock market rout. Citigroup’s Morse believes if oil prices remain low it will act as a “huge quantitative easing programme which would help to spur sputtering economic growth”. The decline in prices would generate a $1.8bn daily windfall for the global population in lower fuel costs, or some $660bn annualised, he argues. “Tracking this into gasoline prices in the US, where last year some $2,900 per household was spent on gasoline, the windfall would amount to a tax rebate of just under $600 per household.”
The reduction in oil prices has already pushed down petrol prices in Britain and helped reduce costs for farmers. There has been a 14% fall in UK wholesale gas prices, which is partly linked to global oil prices, although this has yet to be translated into household bills.
Peter Atherton, a utilities analyst with stockbroker Liberum Capital, says it is now possible to predict that wholesale power prices in Britain will rise from around £50 per megawatt hour to around £57 by 2020, which is considerably less than many had feared.
After that, he says, a series of government interventions aimed at supporting the building of new gas-fired power stations, windfarms and nuclear plants will push prices up as the costs are passed on to households. These low-carbon initiatives – which are partly aimed at beating climate change, but also billed as a hedge against rising fossil-fuel costs – could cause trouble for governments in the future. “If the rest of the world is enjoying cheaper energy costs, will the British public be willing to foot 20% to 40% higher bills? Maybe the climate change argument will be enough but maybe it won’t,” Atherton asks.
Some industry experts do indeed believe that, far from hovering around the $110 seen in recent years, the oil price has moved into a new phase of being priced closer to – or even lower than – $80. But Ann-Louise Hittle, head of macro oils research at consultant Wood Mackenzie, disagrees. She believes too many governments in countries dependent on oil and gas revenues have too much to lose from a long-term price slump. “We do not think oil prices can remain well below $90 per barrel for this reason,” she says.
But Nick Butler, a former BP executive and an energy adviser to Gordon Brown, is not sure anyone has much control over volatile crude markets any more. “Once started, a price fall is going to be very hard to reverse,” he says. “Much of Saudi Arabia’s power is psychological – people have believed that because they have controlled prices in the past they will do so for ever.”
Oil price winners and losers
Oil prices have an effect across the UK economy. Lower prices have started to drive down petrol costs – cutting the business costs as well as consumer bills – and reduced the price of wholesale gas and electricity. UK inflation has already been pushed down by falling energy prices and this should also reduce food costs, as fuel is a significant element in food production. But it is not all good news: lower crude values will also reduce the profitability of the North Sea and cut tax revenues. Much depends on how long prices stay low. Here are the winners and losers so far.
Consumers It is no surprise the supermarkets have started a price war on the petrol forecourts. Sainsbury’s, Asda and Tesco have all slashed pump prices: some now charge 126.7p a litre for diesel and 123.7p for unleaded petrol. In spring 2012, motorists were paying more than 137p for unleaded, and this put enormous pressure on George Osborne to scrap planned fuel duty rises. Much of the cost at the pump is tax, but further falls in the oil price should bring more relief to drivers – while possibly increasing car miles and carbon emissions. Energy suppliers are resisting passing on the lower wholesale gas and electricity prices, citing a possible price freeze by a Labour government next spring. If wholesale costs remain low – gas is down 14% – the big six suppliers will be forced to act.
Industry The price of fuel is not only a pain for consumers; it hurts farmers, airlines and manufacturing. September’s fall in inflation – to its lowest level in five years at 1.2% – is partly a consequence of lower energy, food and transport prices. Transport is a major part of agricultural costs, and supermarkets spend a fortune trucking goods around the country. Airlines are acutely vulnerable to oil-price rises and should be able to reduce fares if lower energy costs persist. Falling energy prices may ease some of the pressure the government is under from energy-intensive industries such as cement and steel, which often complain they are uncompetitive against countries such as the US, where the shale gas boom has driven down energy costs.
Armed forces The biggest single user of fuel in the world is said to be the US army, so lower fuel costs in theory could mean more military manoeuvres by America. But its current number one adversary, Russia, derives more than half of its revenue from oil and gas, and its economy could be driven into recession by a prolonged reduction in commodity costs. Oil and gas prices are linked in many of the world’s biggest contracts. The Kremlin’s military intervention in Ukraine has made Europe more aware of its dependence for its energy security on Russian gas exports, but this is less of a worry if Moscow’s economic power is weakened.
Scotland The economic power of Scotland is diminished at times of low oil prices. The Scottish National Party based much of its economic model for independence on extracting a further 24bn barrels of crude, but that presumed a global price of $100 a barrel. Now it is under $90 and some say it will fall further. Alex Salmond was hoping to raise $1.5tn of tax revenues, but lower oil prices would reduce that. The North Sea is already a high-cost domain and it will become of less interest to oil explorers than lower-cost regions where huge discoveries could still be made.
Power generation The past high price of wholesale gas and the relatively low price of electricity have led to many gas-fired power stations being closed or mothballed, but although falling gas prices have helped generators, they will need to fall further for many of those plants to break even. Cheaper gas also undermines the competitiveness of other forms of power generation such as wind and nuclear. A period of low gas prices could make subsidies for new reactors at Hinkley Point in Somerset and new wind farms and solar arrays look even more toxic. Lower gas and oil prices should reduce investor interest in UK shale-gas fracking, which would delight environmentalists but disappoint the government and industry supporters. But overall, lower fossil fuel prices - oil, gas and coal - will weaken the hand of those arguing for a low-carbon economy.
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