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Impact of low oil prices on investment part 1

Hydrocarbon Engineering,

Below are highlights from a speech given by Maria van der Hoeven, Executive Director, International Energy Agency (IEA) on the impact of low oil prices on investment.

“For every single barrel of oil that is saved in OECD member countries due to energy efficiency measures, two barrels are consumed in the developing world. Clearly our global energy system is going through a period of transition, and one aspect of this transition made headlines in 2014, with oil prices plunging to five year lows. Newspapers revelled in the opportunity to print doomsday headlines such as ‘the casualties of cheap oil’ and ‘uncertain economic fortunes in a world of cheap oil.’

“Yet the world has not ended. In fact such swoons are not unprecedented, and we have come to expect them every 10 year or so. The volatility of fossil fuel prices is a signature of the energy sector, and a natural reflection of basic economics. However, one of the things that makes this time different, at a fundamental level, is that it has happened in a time of the energy transition.

“Of course energy transition can mean different things depending on whom you talk to, and indeed it’s almost meaningless insofar as the energy sector has always been changing, adapting and evolving.”

Oil market rebalancing

“In terms of oil, what we are seeing today is a rebalancing of the market. The result of this rebalancing will be a market that looks different from the market of yesterday. Both demand and supply patterns have shifted. By unlocking light tight oil, a vast resource that long seemed off limits, the US has changed the rules of the game and effectively becomes a new swing producer. Oil supply from outside of OPEC is becoming far more price elastic than in the past, while demand becomes significantly less so.

“But of course, weak demand should come as no surprise. For one thing, the world economy remains relatively weak itself, and overall oil intensity is also decreasing, that is, countries are experiencing economic growth with less oil, relatively speaking, than they were previously. These factors are part of the reason prices fell in the first place, and make it less likely that lower prices will in and of themselves fuel a large increase in demand. This is not to say that demand growth will not gain momentum as the global economy slowly improves. But it will do so more slowly than had been expected, in line with the IMF forecast of underlying economic growth.”

Fossil fuel consumption subsidies

“There are quite a few economic benefits to be expected from lower prices. These can include higher household disposable income, and lower industry production costs. However, these benefits may be partly offset by deflation in some OECD economies. Outside of the OECD, relatively weak currencies mean that lower prices in US dollars will not necessarily seem that much lower to end users in domestic currencies. This will be compounded by the fact that many governments are rightfully seizing the opportunity of lower prices to dismantle their costly and ineffective subsidy programs.

“Rightfully, because low oil prices represent an opportunity make smart decisions on subsidies, specifically those that result in prices paid by end users being reduced to below international benchmarks. For example, in Saudi Arabia, gasoline prices at the pump are one eighth what they are in London. These are known as fossil fuel consumption subsidies, and are an extremely inefficient means of achieving their stated objective, which is typically to help the poor.

“In 2013, governments around the world spent US$548 billion on such fossil fuel consumption subsidies. This is more than five times the level of support that went to renewable energy. It is also twice as much as actual investment into renewables in 2014. 10 countries account for almost three quarters of this sum, and five of them are in the Middle East and North Africa. In fact, more than one third of electricity in the Middle East is generated using subsidised oil. In the absence of these subsidies, almost all renewable energy technologies, including nuclear, would be competitive with oil fired power plants.

“Outside of the Middle East, we have seen promising moves to dismantle subsidies in Indonesia, starting with gasoline, while diesel prices in India have been deregulated and tax reforms in China are limiting the benefit of lower oil prices for consumers.

“These are wise and prudent measures to be taken, especially at a time when the future of oil supply in the Middle East and across OPEC is being questioned. The move by the group’s core Gulf members last November not to cut production in defence of prices was only the first step in a plan that includes actually ramping up output and aggressively investing in future production capacity, even as their non-OPEC counterparts keep tightening their belt. But despite OPEC’s stated policy of defending market share, it is expected to contribute only roughly one third of global capacity growth to 2020. It will succeed in regaining a larger market share in terms of global supply, but only up to a point. OPEC’s share of global production will grow, but it will not revisit the higher levels reached before the financial crisis of 2008.”

“Iraq is a good example of how the effects of low prices can be double edged. On the one hand, the price drop makes production both more difficult to finance and less profitable. On the other hand, it is an incentive to raise production volumes to make up for the loss of revenue, and to quickly resolve problems that had been holding down production.”

Further highlights from this presentation can be found here.

Edited from speech by Claira Lloyd

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