The fall in the oil price — just above $52 a barrel for Brent at the end of the week, a drop of more than a third in less than 90 days since the beginning of October — is more than another symptom of the market uncertainty surrounding the US economy that produced dramatic end-of-year falls in stock prices.
Expectations of a serious downturn in economic activity in 2019 certainly matter, but the driving factor behind the drop in oil prices is the continuing excess of supply over demand for crude and oil products. The market is a truthful signal of the underlying realities. For some players in the market the fall will have come as a nasty surprise. Many, including some leading hedge funds, were clearly expecting prices to rise this year — levels of $80 to $100 a barrel were widely forecast.
Rising demand combined with production cuts seemed to make the upward trend an easy bet. Venezuela and Iran, for different politically driven reasons, are both producing and exporting almost 1m barrels a day less than they did a year ago. On top of that, Opec agreed at its December meeting a production cut of more than 1m b/day. But the market has clearly underestimated the supply, particularly from the US and other countries outside Opec. Demand has risen a little this year — by around 1.3m b/d on the latest estimates from the International Energy Agency. But production, led by US shale oil, has covered that growth despite the decline from Iran and Venezuela.
The market is awash with oil and it will take something much bigger than the minor reduction agreed by Opec to bring a new balance. We may not have seen the bottom of the price trend yet, particularly if there is a recession in the global economy in 2019. So who wins and who loses in this volatile environment? The winners are the oil majors that have systematically cut costs and rebased their activities to achieve profitability across their operations, even if prices stay around $50 a barrel for some time. In most cases, dividends are safe. The ability to do this is a mark of their continuing strength and resilience. They are now well positioned, as in past downturns, to pick up the pieces from other companies across the industry who are more dependent on high prices.
A wave of consolidation seems likely. US president Donald Trump is a winner of sorts: he has argued for lower prices and has got what he wanted, but there could be costs as well if the price fall causes serious political instability. The losers are the producing countries that have failed to reduce their dependence on oil revenues or to make their national oil companies viable in a low-price world. They face a period of budget deficits, increased debts and reductions in both current spending and longer-term investment.
There could be serious and much wider social and political implications in 2019 in areas that are already fragile. Nigeria, Venezuela, Angola and even Russia are just some of those ill equipped to cope with another sharp fall in earnings from oil exports. In north and west Africa and in the region around Venezuela the risks of a new exodus of economic migrants in 2019 is very high. A medium-term price of $50 a barrel is sufficient to sustain most existing production across the world, although with the US West Texas price down to the mid $40s there is a question mark over some of the shale operations.
The Permian Basin, the main source of production growth in the short-term, should be safe but other regions may suffer if low prices persist. In purely economic terms, consumers stand to gain. China, now an importer of more than 9m b/d of oil, will benefit in terms of a reduced import bill, but the volatility should be a reminder to the authorities in Beijing of the energy security implications of their dependence on supplies from regions whose stability they cannot control. Will the trend turn in 2019?
If the US enforces the sanctions regime against Iran in full, the chances of a upturn are strong. Beyond that, probably not. For most producers, the instinctive reaction to low prices is to maximise output in order to sustain revenue. Opec — which now in practice means Saudi Arabia — appears too weak economically to risk making the cut of 2m to 3m b/d necessary to push prices back towards $70.
Demand will keep rising but there is no shortage of supply. Welcome to the age of plenty.
The writer is an energy commentator for the FT and chair of the King’s Policy Institute at King’s College London.