What caused the recent crash in the oil price from $110 (Brent) in July to $70 today and what is going to happen next? With the world producing 94 Mbpd (IEA total liquids) $1.4 trillion has just been wiped off annualised global GDP and the incomes of producing and exporting nations. Energy will get cheaper again, for a while at least. The immediate impact is a reduction in global GDP and deflationary pressure. There is a lot of information to review and summarise and so this week and next we will present the story in stages culminating we hope with an oil market forecast scenario.
Figure 1 Global oil production has been split into three geo-political categories: 1) USA and Canada, 2) OPEC and 3) the Rest of the World (RoW). RoW production bears the hallmarks of having peaked in the period 2005 to 2010 and this has consequences for oil prices, demand and prosperity in parts of the world, especially the OECD (Figure 3). Most of the growth in oil supply has been in the USA and Canada where the market has been flooded with expensive oil. Data are crude oil + condensate + natural gas liquids (C+C+NGL) and exclude biofuels and refinery gains that are included by the IEA in their total liquids number.
The concept of peak oil remains controversial. One school observes that the Olympic Peak of July 2008 (87.9 Mbpd, total liquids IEA) has been swept away by successive production records, the latest data from the IEA showing 94.2 Mbpd. In a recent post I showed that all of the growth in total liquids since May 2005 has come from either low quality (NGL) or expensive supply (light tight oil [LTO] and tar sands) (Figure 2). And most of this growth is located in the USA and Canada.
Figure 2 Global production of conventional crude oil and condensate has not changed since May 2005 despite a prolonged spell of record high oil price. All of the growth has come from expensive LTO and tar sands. The toxic mix of high debt and losses in the LTO industry that are in the making may short circuit the global banking system again.
But while the USA and Canada have been bathed in the warm glow of growing supplies of expensive oil, the RoW has seen their supplies stagnate and fall (Figure 1). The importing countries like most of Europe, China, India, Japan and S Korea are all competing for finite supplies from OPEC. Since oil is often seen as the lifeblood for the global economy, not managing to access enough of it at the affordable price you want inevitably strangles growth out of the economy. It is this competition for supplies that has underpinned $100+ oil and undermined economic growth for so long.
Figure 2 OECD oil consumption crashed under the weight of high oil price, debt and the near collapse of the banking system and never recovered. Low oil price, if it lasts long enough which is doubtful, will help stimulate demand for oil in the OECD which most western governments appear to be ambivalent about. Based on a chart by Art Berman.
OECD oil consumption fell dramatically in the wake of the crash and has never recovered. The anti-fossil fuel lobby that seems to have the ear of most OECD governments and institutions will be pleased with this outcome. If you are Portuguese, Spanish, Italian or Greek and had to sell your car, less so.
Global debt levels are clearly a part of the big picture which includes the expansion of debt in North America to expand LTO and shale gas production and expansion of debt in China to expand Chinese consumption. LTO and shale gas are both expensive to produce, and the conundrum that the producers and banks still face is how to rationalise over production of an expensive resource that dumps the price and creates a loss for both producer and bank.
Low oil price will have two predictable outcomes. It is going to result in reduced production, not only of LTO but across the whole oil market including OPEC. Even although OPEC voted to not reduce supply, the market forces that OPEC increasingly operates under will do the job involuntarily for them. A rout in the LTO producers is widely anticipated. And returning to Figure 1, low oil price is going to sharpen that oil production decline in the RoW. Possible to anticipate but impossible to forecast, global oil production will be heading down in the next 12 to 24 months. But lower prices are going to come as an enormous relief to consumers who will go out and consume more. The OECD and the RoW will emerge with reduced oil production capacity and increased thirst for oil.