Tuesday, July 30, 2013

Shocking oil shocks ahead?

Let's start with the source:

The world might be drifting into an oil price shock
Paul Stevens, Financial Times, 25 July 2013 (hat tip: NC)

Not the usual way to look at an article at FT is to do a search of the title, click on the link, and then fill out a little survey.
There are two new dimensions to international oil markets that are creating a dilemma for Opec and may be sowing the seeds of an oil price shock. The first is the fallout from the Arab uprising, which began in 2011. The second is the development and application of shale technology – horizontal drilling and hydraulic fracturing or “fracking” – to oil production.
A significant consequence of the upheaval in the Middle East and north Africa is that oil-producing governments need more revenue to pay for social policies that will assuage popular unrest. This requires higher prices. For example, in 2008 it was estimated that Saudi Arabia needed about $50 a barrel to balance the books. Last year estimates put the figure closer to $95. 
Such high prices will produce market responses and this is where shale technology comes in. This relatively high-cost technology has led to a dramatic increase in oil production, most obviously in the US. The new Review of World Energy Statistics from BP shows that 2012 recorded the highest single-year increase in US oil production ever.
What they seem to be arguing, is that the unsustainable demographic pressures in the Middle East are contributing to higher prices, which will open the doorway to new (higher cost) resources, which will simultaneously cause supplies to be flush, and a crash in demand due to the initially high prices.
They are making the reasonable presumption that Saudi Arabia is not in a position to act as the oil price regulator: keeping prices low enough to inhibit competition, while high enough that they can make money.
All of which strikes me as a reasonable wild ass guess.  It is not at all unusual for there to be cycles within cycles.  The obvious, large question is the price of this new extraction.
What I find interesting is the last paragraph, which brings in a sort of secondary effect of this scenario:
If prices do drop, it could lead to further unrest in oil-producing nations, spooking the markets. The result would be much greater oil price volatility. In that case, security of supply concerns – based on fears of physical disruption – would be overtaken by concerns about the macroeconomic impact of oil price volatility. At the very least, this would increase pressure to further regulate the paper markets. 
For producers it would bring to the very top of the agenda the need to diversify their economies away from oil dependence. This has long been an aim but for the most part with very disappointing results which will, in turn, feed the consequent political upheavals. Overall, oil markets are in for a rough ride.
Part of that is an obvious swing at the American Bankers (J.P. Morgan and Goldman Sacks come to mind) who have been accused of manipulating the commodity markets to their advantage.  After J.P. Morgan was hit with massive penalties they have decided to get out of the business, so talking about regulation after the horse has left the stable is safe for a captive news source.

But even in a rose tinted scenario, the up side has a pretty nasty down side.  My wild ass guess is that oil won't get all that cheap, and we will still have a lot of instability: but that's just me being gloomy.   Supposedly post-Japanese melt down, a number of countries are supposed to be abandoning their nuclear reactors.  That is a lot of energy for sustainable sources to make up on their own, and even the sustainables require fuel inputs on the front end.

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