The New Economics of Oil
by George Hatjoullis
Every now and again wandering the corridors of social media one stumbles across interesting stuff. This time it is a presentation by Spencer Dale, now chief economist for BP. The presentation is titled The New Economics of Oil, is not very long and quite accessible. Worth reading the original but here is a quick summary. Dale dismisses four stylised ‘facts’ about oil.
- Oil is an exhaustible resource
Clearly not so. High prices have motivated new technologies of extraction which has recently increased reserves. Moreover, climate considerations are acting to limit demand growth. The assumed constant upward pressure on prices is thus no longer valid.
2. Oil supply and demand curves are steep
This implies that changes in supply and demand impact price disproportionately, at least in the short-run. High price-volatility is thus to be expected. No longer suggests Dale. Shale oil has changed the price dynamics. The production cycle is much quicker and the life of reserves much shorter making investment and production correspond more closely. Output can react more quickly to changing conditions so that price changes are less dramatic.Moreover, variable costs are relatively high (compared to fixed costs). There is thus a great incentive, as well as ability, to adjust production. However, shale producers are also smaller and more leveraged, which exposes the oil market to financial shocks. This may introduce price volatility from a different source.
3. Oil flows from East to West
Falling demand and greater internal supply has changed this materially. Demand growth is now from the (far) east. Moreover, fund flows from west to east are now being reversed. This suggests that the Dollar appreciation may be structural rather than cyclical. Most important is the geo-political implication as the leverage that the (middle) east and Russia had diminishes. A wider distribution of energy resources is a force for stability in geo-politics ( as I have argued in earlier blogs). China’s increased exposure probably explains the ‘One Belt, One Road’ strategy.
4. OPEC Stabilises the Oil Market
OPEC could never stabilise the market in the face of structural shocks, only temporary shocks. This has not changed. In the face of structural shocks OPEC can only keep pumping and retain market share. It is still the dominant producer and can still effect supply in the short-term. However, in the face of structural shocks it has no incentive to do so.
Four new principle of oil economics should include:
Oil unlikely to be exhausted and thus no presumption that the real oil price will increase.( This was a strong planning assumption at BP in 1981/2)
Oil prices are now likely to be less volatile.
Oil will now flow west to east. This will have significant financial and geo-political implications.
OPEC remains a force short-term but only short-term.
You might like to read a piece I wrote in June 2009 and reproduced later as one of my blogs. It anticipates many of these trends. It is The Big Picture; a quiet evolution .