Over the last few months, as an Egyptian government fell in a coup, the United States considered an attack on Syria and disgruntled Libyan terminal guards blocked oil exports, the only predictable news was the rise in oil prices to levels not seen in more than two years.
It all seemed distressingly similar to previous oil shocks. That is, until the higher prices suddenly retreated, along with President Barack Obama’s plans to retaliate for Syria’s apparent use of chemical weapons.
What is the lesson of the summer mini-spike? Are we poised to return to $145-a-barrel oil and $4.50-a-gallon gasoline? The answer from most energy experts is probably not, because the fundamental global oil demand and supply equation has changed so drastically over the last three years.
Even before the collapse of plans to attack Syria and the new overtures of Iran to improve relations with the West, the financial company Raymond James published a report forecasting a lowering of oil prices from $109 in 2013 to $95 in 2014 and $90 in 2015. Some analysts are predicting even lower prices, and not only because of the frenzy of shale drilling in the United States and rapid oil sands development in Canada.
“Oil prices at about $100 a barrel is at a sweet spot,” said Paul Bledsoe, senior fellow in the Climate and Energy Programme at the German Marshall Fund. “It’s high enough to incentivise remarkable investment in new production techniques and equally large investments in efficiency improvements. And the underlying factor of relatively modest economic growth seems to be with us for quite a while.”
Predictions about oil and gasoline prices are precarious when there are so many political and security hazards. But it is likely that the world has already entered a period of relatively predictable crude prices. Even at their highest point in late summer, oil prices remained roughly 25 per cent below levels of five years ago, not counting inflation, and gasoline prices on Labour Day weekend were at multi-year lows. And while oil slightly above $100 a barrel oil and nearly $3.50-a-gallon gasoline are high by historical measures, they are at a surprisingly benign level given the on-and-off disruptions in the Middle East and North Africa over the last three years.
No doubt there will still be bumps like this summer’s. But there are reasons to believe the inevitable tensions in oil-producing countries will be manageable over at least the next few years, because the world now has sturdier shock absorbers than at any time over at least the last decade. The new oil equation combines multiple factors that span the globe, and most promise to be more permanent than the lacklustre performance of the global economy, which no doubt has suppressed energy demand.
On the supply side, more oil production in the United States, Canada, Iraq and Saudi Arabia has compensated for the loss of exports from Iran, Libya and other trouble spots. The spread of American shale-drilling technology and skill to developing countries promises to raise oil production around the world, particularly in non-OPEC countries with large untapped shale fields like Mexico, Argentina, China, Australia and Russia.
That may not be good news for the environment, but it could soften pressure on corporate and consumer budgets, at least in the short term.
More friendly to the environment have been changes on the demand side of the energy equation. Auto fuel efficiency is improving by an average of 3 or 4 per cent a year because of improved designs and tougher government regulation. New standards in the United States since 2007 have been followed by mandates in Europe, Japan and Canada. Most important, new standards will take effect in China in 2015, which is critical because its vehicle fleet continues to expand at a rapid rate.
“The greatest source of energy into the future is learning how to use it more efficiently,” said William M Colton, Exxon Mobil’s vice president for corporate strategic planning. He projected that over the next 30 years, the world economy would roughly double in size while its energy needs would increase by a little more than a third.
Colton was nearly as sanguine about the future for oil supplies. “When we talk about stability, the key is to have a diversity of supplies to meet the global need for energy, and I would say the world is moving toward having more sources from more places and that tends to bring more stability.”
Such price stability will bring with it winners and losers. Several producing countries like Venezuela, Nigeria and Saudi Arabia, which depend heavily on oil earnings to finance their governments and social programs, may be in for a shock. That could strengthen the position of the United States and even China, but more instability in places like the Middle East could have unpredictable consequences for the world at large.
Countries with large shale oil resources, like Argentina, Australia and Pakistan, stand to benefit. Mexico is particularly well-positioned, now that the government is rewriting its oil laws to encourage foreign investment, potentially increasing its ability to pump 25 per cent more oil out of the deep waters of the Gulf of Mexico and onshore oil shale fields. Michael Lynch, president of Strategic Energy and Economic Research, a consultancy, said stable oil prices could reduce future inflation rates and particularly curb transportation costs, helping to steady prices of food and construction materials that travel long distances. Lower inflation, he noted, can also help reduce interest rates.
“By reducing uncertainty,” Lynch said, “investor and consumer confidence should both be increased, boosting higher spending and investment, and thus economic growth.”
Just as there have been several periods of extreme oil price turbulence since the 1960s, there have also been periods – the last one being between 1987 and 2004 – when drivers drove into their corner gas station with little to complain about.
It is easy to forget that low oil prices were once taken for granted, encouraging families to “see the USA in your Chevrolet.” After World War II, the United States had an abundance of oil and little reason to conserve it, and if anybody supported its price at all it was the Texas Railroad Commission, which regulated the output of America’s giant oil patch. But by the early 1970s, United States oil production had peaked and the Organisation of the Petroleum Exporting Countries began to impose its will on global oil markets with boycotts and production quotas.
Of course OPEC overreached, and the high oil prices and long lines at the pump spurred the United States and Europe to find more oil and conserve it. Global oil demand declined 10 per cent from 1979 to 1983, and oil production among countries outside of OPEC expanded by more than 12 per cent. Oil prices quickly came down to earth, and OPEC’s command over global oil prices never totally recovered.
When global oil prices ramped up again between 2004 and 2008 from $30 to more than $140 a barrel, OPEC was no longer the primary cause. Rather this time it was a chaotic gyration of supply interruptions. Nigerian rebels were damaging oil pipelines. President Hugo Chavez’s revolution jolted Venezuela’s state oil company into disarray. Oil production was in free fall in Mexico, the North Sea and the United States. On the demand side, a middle class with a taste for gas-guzzling cars was suddenly sprouting in China, India and other parts of the developing world at a rate that would have been unimaginable only a couple of decades before.
The financial crisis put a jolting brake to the trend, sending oil prices down to below $50 a barrel
for a time in late 2008 before bouncing back to the $100 level the last few years – and above that when strife in the Middle East and North Africa spooked traders.
But even as the Brent crude benchmark price leapt up to $116 a barrel this August, American consumers felt little at the pump. In fact, gasoline prices in the United States actually declined by a few cents a gallon over the month, and they continue to fall.
“There is enough oil,” said Miguel Galluccio, chief executive of YPF, the Argentine national oil company. “If tomorrow you have major military action in the Middle East, the speculators will panic and push the price to $130 a barrel, but then it will come back down again. The source of supply is there.”
In fact, American oil supplies increased at the height of this summer’s Middle East crisis and driving season, allowing many refineries to ramp up production to meet demand without a hitch. The United States continues to consume more than 20 per cent of world oil supplies but now, once again, it also produces an increasing share of world supplies even as Russia and Saudi Arabia pump more.
Just as the Arab boycotts of an earlier era spurred robust exploration in Alaska and the development of the Trans-Alaska Pipeline, the recent oil price spike from 2004 to 2008 spurred an even more impressive expansion of domestic drilling across Texas, North Dakota, Oklahoma, Louisiana and in the deep waters of the Gulf of Mexico.
US oil production alone has mushroomed by roughly 3 million barrels a day in the last six years to the highest levels in nearly a quarter of a century, and it should continue to grow from a current 7.6 million barrels a day to 9 million barrels a day by the end of the decade, Faisal Khan, managing director of Citi Research, told a Senate committee this summer.
Turner, Mason & Co., a Dallas-based engineering consulting firm, projects a low-case forecast of 9.5 million barrels produced domestically by 2022, which would be just short of the record of 9.6 million barrels produced in the United States in 1970. But its high forecast is 12 million barrels, potentially making the United States the world’s biggest producer. Higher American production means Washington has greater flexibility to release strategic reserves should prices begin to rise in a way that threatens Western economies.
Canadian oil production is also rising fast because of the development of western oil sands, and experts say an increase in production of 200,000 barrels a year can be expected over the next decade, although an Obama administration decision to deny the proposed Keystone XL Pipeline could slow development.
“Strong production growth in the US and Canada will serve to keep a lid on crude prices,” a recent Turner, Mason study predicted. It also forecast that the benchmark price for Brent crude would average from $95 to $105 a barrel over the next decade, which is below current price levels.
And while the United States is producing more oil, it is consuming less year after year. The United States currently consumes a little more than 18 million barrels of oil a day – more than 2 million barrels below peak consumption in 2005.
High unemployment is a major reason but far from the only one. Federal mandates for biofuel use have replaced nearly 10 per cent of oil in gasoline production over the last five years, although corn ethanol production also burns fuel. Natural gas is chipping away at oil use for heating in the Northeast.
Energy experts note that more people are shopping online, more employees are telecommuting, and young adults are attracted to an urban lifestyle where work and play are closer to home. The American car fleet is gradually being replaced with autos that will be far more efficient under the new fuel mileage standards.
By 2018, the Paris-based International Energy Agency projects US oil demand could fall by more than a half million barrels a day, an additional decline of nearly 3 per cent from current consumption.
And that could be conservative, especially if cheap natural gas replaces more oil as a transportation fuel. There are currently 8 million heavy and medium-weight trucks on US roads consuming 3 million barrels of oil a day – about 15 per cent of total US oil consumption. With big transportation companies like United Parcel Service making the switch and natural gas stations spreading over the last few years, energy experts project that 30 per cent of the fleet could shift from diesel to gas by the end of the decade.
With the United States producing more and importing less, the driver of global oil demand is quickly shifting to China, which has accounted for more than half of the global oil demand growth since 2008. The Energy Department predicts that China will surpass the United States as the world’s largest importer of oil by late this year and it should remain that way for many years to come.
Millions of increasingly affluent Chinese, like the emerging middle class in India and other developing countries, are buying cars. But with the Chinese government beginning to put limits on car purchases in cities as a pollution control measure, the rate of growth in oil demand in China is already starting to ebb. Chinese oil demand declined slightly in the first half of 2013, although most experts believe demand will pick up again but at a slower rate.
“In a pattern similar to the abrupt slowdown in demand growth seen in the Asian Tigers in the 1990s,” according to a recent Citigroup research report, “Chinese demand growth has slowed to a more tepid 3-5 per cent (annual) rate as compared to the double-digit growth seen in the early 2000s.”
The investment bank Canaccord Genuity projects a 3.5 to 4 per cent annual growth rate in Chinese oil consumption for the next four years. But with demand expected to decline in Western Europe, several developed Asian countries and North America, the global demand growth should be just over 1 per cent a year over the next several years. That is nowhere near the conditions that helped spur the price spike before the recession hit.
Countries around the world are getting on the efficiency bandwagon, not only improving auto efficiency standards but also gradually cutting fuel subsidies to ease government financial burdens. The growth in the liquefied natural gas export market is encouraging countries to substitute natural gas for oil in home heating and for industrial power generation.
The advent of US natural gas exports over the next decade, combined with growing supplies from shale drilling around the world, is likely to lower natural gas prices and speed up the replacement of petroleum products with gas for the petrochemical and other industries particularly in Asia. Just as the United States largely substituted natural gas for oil to generate power after the Arab oil boycotts of the 1960s and 1970s, China, India, Latin America and several Middle East countries are expected to follow suit over the next decade or so.
The swing from oil to natural gas as a transportation fuel is already spreading around the developing world from Argentina to Pakistan. China has been particularly proactive, and already has more than 40,000 trucks fueled by liquefied natural gas.
“There is enough natural gas and it is cheap enough and the technology is mature enough that for the first time we can talk seriously about fuel switching in transportation to natural gas,” said Michael Webber, deputy director of the Energy Institute at the University of Texas at Austin. “And while oil is still dominant, we also have biofuels and electricity as options so the century-long monopoly that oil has enjoyed is starting to show some fissures.”
Information from New York Times was used in this report.