Nick Butler, in “The falling oil price is a lull in the storm,” argues that the break in oil prices is likely to persist for a bit due to improvements on the supply side, but that falling into complacency would be a mistake.
The bad thing about the volatility in oil prices is that it is an impediment to moving to new sources. The Financial Times, in an editorial last year, stressed the importance of having a stable price for carbon to facilitate the transition to cleaner sources. But as much as the runup of oil to nearly $150 a barrel led to conservation in advanced economies (which is far and away the biggest opportunity over the short to intermediate term), the sudden drop to almost $110 leaves open the possibility that it might retreat further (which this article contends will happen later in the year), which would call the viability of alternative energy into question and may also lead to more consumer use (at a minimum, airlines may be able to lower prices and add flights although their nickel and diming is no doubt here to stay). But governments seem loath to design tax regimes designed to achieve a certain end price.
From the Financial Times:
The explanation for the change in sentiment [on oil prices] lies in a combination of factors that between them are transforming the level of spare production capacity – a measure that over the past two years has become the leading indicator of world oil prices and a signal to speculators.
First, demand levels have slipped back and look set to end the year more than 500,000 barrels a day below the initial projections. Demand, especially for petrol , is down in the US and Europe as high prices work through to the pumps and as the economic slowdown takes hold. The Japanese economy, the second-largest single source of energy demand in the world – at 4.5m b/d – shrank by more than 2 per cent in the second quarter.
Almost all the remaining growth in oil consumption is now coming from the emerging markets – especially China and India. Even there the rate of increase in demand has slowed in the past six months. In a market that is sensitive to every change, even the Chinese constraints on car use in advance of the Olympics have had an impact.
More important is the other side of the equation. High prices have encouraged producers to expand output and a series of new development projects around the world, such as the delayed Khursaniyah project in Saudi Arabia and new offshore fields in Nigeria and Angola, are due to come on stream over the next six months.
The net result of these changes is that the level of spare capacity, which dropped at one point to little more than 1m b/d, has crept up to about 1.8m b/d and could rise to 3m b/d by next spring. Three million b/d was the historic level of spare capacity in place throughout the 1990s – a comfortable margin of security against problems anywhere in the world. If such levels are restored the stage is set for a reduction of prices through the autumn and winter. Prices could break through the symbolic $100 a barrel level – only this time they will be heading downwards.
Those brave enough to predict oil prices are usually wrong, but the perception that the fundamentals have changed has begun to affect the trading market and behaviour of speculators. That is why the Russian invasion of Georgia had so little impact. Speculators in particular are pulling out of oil – with a few beginning to bet on a further substantial fall. In the words of one London trader: when prices have risen by more than 100 per cent in 12 months the chances are that the next move will be downwards.
None of this resolves the long-term challenges facing energy policymakers. The world is still dependent on hydrocarbons for more than 80 per cent of daily energy needs. A year of rising prices has only served to shift demand to coal. As a result carbon emissions continue to rise. The dependence of the world’s consumers on Saudi Arabia, Russia and a few other producers remains high. Imports are set to rise in the US, Europe, China and Japan.
The big oil companies are losing market share and seem unable to secure significant access to the few new discoveries being made in areas such as Brazil. The bulk of supplies are controlled by state companies. With Russia and the core of the Middle East closed off, big oil groups face a fundamental challenge to their raison d’être. Falling prices will relieve some of the pressure on consumers but complacency would be misplaced. This is a lull in the storm not a reversion to normality. The need for a transition to a more diversified, lower-carbon energy economy is as urgent as ever.