Energy issues

Here we go again. The price of oil has dropped some 40% since June. Another oil price crisis is in the making. This is getting tiresome. It’s my fifth, or sixth, depending on how much I want to trust my memory. But, this one is different, some say. Sorry to tell you this, but it isn’t.

Already, we are seeing consequences for the industry. Transocean has idled four drillships. Hercules Drilling has laid up the same number of jackups. Other offshore drilling companies, who do not wish to be named, are weighing their options. Further drilling rig construction is looking iffy, at best. Operators are spooked, especially the heavily leveraged, smaller offshore players. Even the major oil companies are holding their breath in the wake of plummeting oil prices since June.

Onshore, shale players are suffering as well. Shale giant Continental Resources has lost half its value. And, the service industry is not immune. Halliburton has lost nearly 44% of its value since July 24.

The damage is also not limited to the U.S., or a few countries. Sustained, low oil prices take a big toll in non-OPEC countries that count heavily on oil revenues, like Russia, where the ruble has lost 40% of its value against the dollar since January, due partly to falling oil prices, and Venezuela, where falling oil revenue has worsened an economic crisis resulting from fuel subsidies, price controls and expanded social programs.

If Chicken Little was evaluating the situation, he would tell you the sky is falling. The question is not if it will fall, but how far it will fall.

The problem is that no one wants to blink. We all look at OPEC, and specifically Saudi Arabia, expecting action from there to address the oil glut. But, why should we? They have a strong historic precedent against cutting oil supply—the oil crises of the 1970s. As some of you may remember, the crises began when Saudi restricted production and exports to punish specific Western countries for participation in the Yom Kippur war.

That move backfired badly. The increase in crude prices worldwide, coupled with restricted supplies to targeted areas, led to rapid development of other oil-rich regions, among them the North Sea, offshore Brazil and parts of offshore and onshore Africa. The lasting result, lingering today, was the loss of Saudi market share worldwide.

To restrict production now, to raise prices, would put Saudi, and OPEC, market share at substantial risk again. Therefore, unless the crisis worsens considerably, it is unlikely that OPEC will take unilateral action to restrict output any time soon. In fact, Iranian Oil Minister Bijan Namdar Zanganeh said publically that the decision to act by OPEC might require “years, not months.”

For most of the world, the decision is not about timing. It is a decision that is almost too tough to make—cut production and lose market share, or let it ride and lose crucial oil revenue. When the decision comes, it will be a last-minute, end-of-the-rope reaction. And, even that might not be enough. Waiting in the wings is something over 1.0 MMbopd in potential that could hit the market, if Libya fully restores production, Iraq expands output, and Iran settles the issues with its nuclear program, and sanctions are lifted.

In logical terms, what needs to be done to address the current “oil price crisis?” A Citibank analysis recently noted that current low prices will not stop shale oil development and production growth in the U.S., it will only trim that growth by about 30%. But, that fall in growth rate still results in increasing supply, with that supply vying for a shrinking market. Oil demand is weakening worldwide. China’s economy is stumbling a bit, with factory activity slowing more than expected. Eurozone manufacturing growth is stalled, with new orders falling rapidly. Moody’s recently downgraded Japan’s credit rating, citing “rising uncertainty” over the country’s debt and the current administration’s faltering attempts to stimulate economic growth. In short, the demand side of the economic equation, in terms of oil, is faltering.

So, what options are logical and viable? Well, many U.S. readers may not want to hear it, but the problem lies here, and the bulk of any solution must come from here. That, in itself, is a double-edged sword. Failure to act, on the part of the U.S., to increase prices by restricting shale production, either by voluntary shut-ins or through longer-term cuts in exploration and development, will sustain the larger economic benefits to the nation of lower-priced oil. Americans are currently saving about $630 million a day on gasoline, compared to prices paid in June. With sustained low oil prices, this could amount to a savings of $230 billion per year, according to the Washington Post. Prices for aviation fuel also have dropped considerably, although it is not likely that much of that savings will be carried over to the consumer by the airlines.

Sales of larger, less-gasoline-efficient vehicles are projected to rise. In fact, almost everything in the larger economy that uses oil-based fuel, from agriculture to education, is likely to benefit economically from low oil prices. On the other side, efforts to increase prices by limiting production will impact shale oil-producing states heavily, most importantly Texas and North Dakota, while largely eliminating the economic benefits of low oil prices to the economy as a whole. However, it will stabilize incomes for important international producing countries.

The best bet is that this crisis, and this debate, will end with some unforeseen international event that alters output in a major producer. That’s the way these things have worked before.