The oil industry has changed. There was a time when the oil price could be forecast with some precision. These days, trying to forecast the oil price with precision is a mug’s game: a futile activity, mainly guess work. When, in 2016, investors asked the CEO of Exxon Mobil, Rex Tillerson, what his view of the future of the oil market was, he replied: “We’ve never been good at predicting those (price) cycles, neither when they occur nor their duration. We don’t spend a lot of time trying…How the future is going to look, we take no particular view on it, other than to recognize that whatever it is today it will be different sometime in the future, and after that it will be different again.”
Two developments are mainly responsible for the changes in the long-term outlook for oil markets: The rise of U.S. tight oil production (shale revolution) and concern about the oil industry’s contribution to climate change. These two developments have had the most profound impact on the economics of the oil industry. The industry has witnessed a switch from a focus on ‘peak oil supply’ about a decade ago, to ‘peak oil demand’ currently. For most of the past 50 years, oil industry analysts generally believed that recoverable oil would become harder to find and thus scarce, leading to ever-increasing oil price. This assumption was the textbook assumption, the Hotelling model (named after the economist Harold Hotelling). The Hotelling model basically states that oil in the ground is an exhaustible resource and its value would continue to rise over time.
The major global policy intervention since the oil price crash of 2014, relevant to the oil and gas industry, is the United Nations Paris Agreement. To limit the risks and effects of global climate change, in 2015, an international agreement was reached to prevent global average temperate rise from exceeding 2 °C above pre-industrial levels and limit any increase to 1.5 °C. Known as the ‘Paris Agreement’, it operates within the United Nations Framework Convention on Climate Change (UNFCCC) and will commence in 2020 aimed at greenhouse-gas-emissions mitigation, adaptation, and finance. Representatives of 196 countries (including Nigeria) adopted the agreement on 12 December 2015 and each country must determine, plan and report (regularly) on its global warming mitigation efforts. A climate accord such as the Paris Agreement will surely impact oil and gas production, if producer and consumer countries take the agreement seriously. Oil reserves may become ‘stranded’ or ‘un-burnable’ when there is a commitment to limit global temperature rise to 2 °C or less. This is the concept of a ‘remaining global carbon budget’ in order to limit the global temperature rise. Researchers at University College London revealed that a third of global oil reserves must remain unused between 2010 to 2050 if the Paris Agreement target will be achieved.
Spenser Dale, Chief Economist of the international oil company BP, articulated a ‘new economics of oil’ in a thoughtful 2015 paper. Traditionally, four core principles guided economists’ thinking about the oil industry: 1. Oil is an exhaustible resource. 2. Oil demand and supply curves are steep. 3. Oil flows from East to West. 4. OPEC stabilizes the oil market. But, according to Spenser Dale, “The oil market has changed very significantly over the last 10 or 15 years. The principles and beliefs that served us well in the past are no longer as useful for analysing the oil market. We need an updated set of principles reflecting the New Economics of Oil.” So, he revisited the four principles: 1. Oil is NOT an exhaustible resource. Some oil reserves may remain stranded deliberately because of carbon emissions policy. 2. Oil demand and supply curves are NOT steep. Shale oil supply is very responsive to price movements, unlike traditional conventional oil supply. 3. Oil flows NOT only from East to West. Traditionally, oil is generally moved globally from the Middle East to Europe and then to America. But now America is a major exporter of oil (ban on export of oil lifted a few years ago). Oil demand from the West has generally decreased and demand from the East (China, Japan and others) has increased. 4. OPEC does NOT always stabilise the market. Traditionally OPEC was the cartel with responsibility for dampening volatility in the oil market. The rise of shale oil in America has weakened OPEC’s influence in stabilizing the oil market.
Uyiosa Omoregie
Dr Omoregie is a petroleum economist and management analyst.
He can be contacted at [email protected]
