Could the price of oil fall to $50? Jan Stuart and Stefan Revielle of Credit Suisse think so. Just think about the implications here: it would touch just about every industry on the planet; many speculators would be ruined; hordes of drillers and prospectors would go out of business. Britain’s drivers, meanwhile, would be thrilled. And it would be a boon for companies struggling to keep their fuel costs down, such as hauliers.
But is it likely to happen? According to these two analysts, investors are becoming increasingly concerned about an oil price collapse. “How bad can things get?” is the question, and their answer is “very bad!” But only if the global economy implodes once again…
The argument runs like this: global imbalances have not been fixed; indeed, in some cases they have got worse “and much of the available political and real capital has merely been squandered in the interim”. The cost of fixing things has now escalated, and the inevitably painful process of cutting debt has merely been postponed. But the painful reckoning cannot be put off forever.
For its doomsday scenario, Credit Suisse assumes “a repeat of the collapse in trading and global activity that accompanied the Great Financial Recession of 2008”. “It could happen [very soon] and a recovery would be decidedly sluggish”. Oil demand would deflate sharply, there would be plentiful supply and a recovery would be “halting, fragile, and painfully slow”. The US dollar would strengthen and oil prices would fail to recover to much beyond $80 a barrel in the next few years.
The world is awash with oil
Part of the problem (if you see it as such) is the increase in supply from the USA. This week Francisco Blanche, head of commodity research at Merrill Lynch, has said that “nobody expected output to grow by a million barrels per day last year”. Thanks to fracking, oil is starting to flow from onshore fields in the USA. This technological breakthrough has already crushed the price of gas and the drill rigs have moved over to the oil fields.
Unlike with gas, this has a global impact. Because gas is best transported through pipelines, it tends to serve only the local market – although investment in liquefied natural gas is increasingly creating a global gas market. But oil is already a global market. There is an international price for oil and this is now being affected by what Credit Suisse calls “stunning large exports streams from the US Gulf that are finding their way into Europe, Latin America, and Africa”.
The bottom line is that supply is tending to increase and, as this is taking place outside the Middle East, it is weakening OPEC’s grip on the market. As ever, the picture is complicated. The Chinese economy is at best in transition, but at worst is facing a severe contraction. The troubles in Egypt, which controls the Suez Canal, are a further sign of tension in the Middle East. And while I would not dispute that many European leaders are doing good ostrich impressions with their heads buried firmly in the sand, other countries are starting to tackle deficits without doing much harm to growth prospects.
Who would win and who would lose?
The future of energy prices is important, however. While nervous traders might fear a falling oil price, consumers around the world would welcome it hugely. Except for those countries that rely upon oil production, a lower oil price would surely boost activity, free up cash to be spent elsewhere and, by cutting inflation, allow interest rates to remain low. I can imagine the joy of the UK’s hard pressed road hauliers, but I can also envisage anxiety elsewhere.
Government and corporate policy assumes a high oil price. Oil is not only dirty, but it is expensive and in declining supply. For the last decade, countries have been trying to wean themselves off their dependence on oil. Alternative energy projects from wind to wave have been promoted; nuclear looks cheap, if dangerous; underground coal gasification has been touted.
Above all, gas is enjoying a renaissance. Exploiting the gas found off the coast of Lancashire and elsewhere is a tantalising prospect for a dithering UK government. Indeed, bullish contrarians are very confident that the government will throw its weight behind natural gas. The latest report from The Fleet Street Letter is interesting to read alongside the Credit Suisse report. FSL is also very bearish on the economy, but it has a different angle on energy markets. It argues that if a burst debt bubble sends the FTSE plunging, a gas boom in Britain will be one of the few bright spots left for investors. You should read the report here.
Here’s another complication: whole industries have been built around the need to cut oil consumption. Vehicles are being modified to use less of it, or are being powered by electricity or gas. Innovative technologies can convert gas into liquid fuel. Waste-to-energy projects look increasingly appealing. But all of these trends have one motivation – the high price of oil. A collapse of the price might please you and me as we refuel at the petrol station, but it would wreck the plans of many. Having just got used to the shock of $100 oil, a sudden price slump would cause fresh consternation.