The headline news that summarized the petroleum industry in 2014 was the oil price crash. The price of oil has been described as the most important economic variable in the world. The price of oil has far-reaching implications for economies and geopolitics. Crude oil prices fell below the 2009-2014 five-year average in early September 2014. The drastic fall in price was from a monthly peak of $112 per barrel (bbl) in June 2014, falling to $62/bbl in December. Since 2016 the oil and gas market has gone through a period of rebalancing, resulting in modest recovery in prices. Oil price recovery reached a peak of $85/bbl in October 2018. Gas prices have also achieved similar modest price recovery. The industry has now entered what appears to be an expansion phase. The year 2018 was a profitable year for the five largest international oil companies(Exxon, Shell, Chevron, Total and BP), as they exceeded expectations for 2018. This was due to the oil companies more disciplined business approach and a focus on the lowest cost barrels during a period of market volatility. The combined cash flow of the five supermajor oil companies is the highest for at least eight years.
The oil and gas industry has always functioned in cycles since oil production began in the 1860s. The volatility experienced in the past few years are historically the norm in the industry, not an anomaly. Boom-bust-rebound-reversal characterize this industry. Robert McNally’s book “Crude Volatility: The History of Boom-Bust Oil Prices” presents monthly oil price time series from 1859 to 2015 that reveal volatility in oil price. McNally also presents global spare oil production capacity from 1955 to 2015. Spare oil production is important as it can act as a buffer in times of undersupply, not only helping to increase the supply of oil but also tempering oil price spikes.Axel Pierru, James L. Smith, and TamimZamrik, in a 2018 article published in Energy Journal, claimed that: “OPEC’s spare capacity reduces oil price volatility and generates between $170 and $200 billion of annual economic benefits for the global economy.Investments in spare capacity provide value to the economy because deploying the production held in response to disruptions saves costs that result from price volatility. This value can be calculated by subtracting the gross domestic profit (GDP) losses that the world would expect to suffer even after deploying the spare capacity buffer from the expected losses without the buffer. The expected losses depend on the buffer size, the magnitude and persistence of the shocks, and on the global GDP losses incurred when there are production shortfalls.”
Before OPEC, oil price volatility was tempered by a cartel formed by international oil companies. At the same time, quotas were imposed the American government on oil production in the country. This alliance resulted in 40 years of relatively stable oil prices between 1932 and 1972. OPEC took over in the early 1970s as stabilizer of oil prices with mixed success. The American oil industry is back to relevance since the shale oil boom began about 10 years ago. The American shale producers are independent companies, purely profit driven with their production very sensitive to oil prices. They are marginal producers in the sense that they produce at the margins in response to oil prices, they price takers not coordinated price makers. It now appears that the oil industry is back to volatility. Increase in the price of oil above a certain price will lead to more production by American shale producers. An increase in production may flood the market leading to a decrease in the price of oil. So, the oil price circle goes round and round.
Robert McNally states: “Extreme volatility…is an intrinsic feature of the oil industry. Historically, oil prices have experienced multi-decade eras of relative stability and wild, boom-bust gyrations…recent fluctuations mark a return of a free and unfettered market for crude oil, and as a consequence boom-bust oil prices are making a return after eight decades.”
Nigeria should take advantage of the current oil price recovery while it lasts. Important projects that were put on hold due to the low oil price must be reconsidered. Let’s enjoy the oil price recovery while it lasts!
Uyiosa Omoregie
Uyiosa Omoregie is a petroleum economist and management analyst.
He can be contacted at [email protected]
