A historic change of roles is at the heart of the clamour and turmoil over the collapse of oil prices, which have plummeted by 50 per cent since September 2014. For decades, Saudi Arabia, backed by the Persian Gulf emirates, was described as the “swing producer.” With its immense production capacity, it could raise or lower its output to help the global market adjust to shortages or surpluses.
But on November 27, at the Opec meeting in Vienna, Saudi Arabia effectively resigned from that role and Opec handed over all responsibility for oil prices to the market. Opec’s decision was hardly unanimous. Venezuela and Iran, their economies in deep trouble, lobbied hard for production cutbacks, to no avail. Iran accused Saudi Arabia of waging an “oil war” and being part of a “plot” against it.
By leaving oil prices to the market, Saudi Arabia and the emirates also passed the responsibility as de facto swing producer to a country that hardly expected it – the United States. It means changes in American production will now, along with that of Persian Gulf producers, also have a major influence on global oil prices.
America was once, by far, the world’s largest oil producer and exporter, and its swing producer. But by 1970, United States oil production had reached its high point and began to decline.
The United States began to import more and more oil. By 2008, its own oil production was down almost 50 per cent from the high point. Oil prices reached $147 a barrel, and fears that the world’s oil production had peaked and that we were beginning to run out of oil had become pervasive.
Quietly, though, an unconventional oil and gas revolution was beginning to pick up speed. It yoked together two technologies: hydraulic fracturing and horizontal drilling. This catapulted the US ahead of Russia to become the world’s No. 1 gas producer.
Then around 2010, the same technologies started to be seriously applied to the search for oil. The results were phenomenal. By the end of 2014, oil production in the United States was 80 per cent higher than it had been in 2008.
Today, American output is almost back to where it was in 1970. On top of that was a million-barrel-a-day gain since 2008 from the Canadian oil sands. The chimera of “energy independence” began to look more tangible, at least for North America.
A price collapse had been postponed by the growing consumption in the developing world, led by China. Another was turmoil in Libya, South Sudan and other countries that reduced supply. Over a million barrels per day were also taken off the market by sanctions imposed on Iran.
By the middle of last summer, circumstances changed. World economic growth was slowing. Europe was on its back and China’s economy was slowing, too, and that meant slowing growth in oil demand.
It was assumed that Opec would step in and cut production to boost the price. Trillions of dollars of investment have been made over the last several years on that premise.
But Saudi Arabia and the other gulf countries declined to do so. If they reduced production, they reasoned, they would lose market share permanently.
They were looking at competition not only from American shale oil but also from Canadian oil sands and new supplies from Russia, the Arctic, Brazil, Central Asia, Africa and growing volumes of offshore oil around the world.
But, most immediately, they were looking at two neighbours. They did not want to give up markets to Iraq, a country they see as an Iranian satellite, and whose output is increasing. And they certainly did not want to make way for Iran, which they thought might come to a nuclear deal with the United States and its allies, bringing that missing Iranian oil back into the market.
The depth of the price fall may be much more than even some of the gulf producers anticipated. Around the world, oil companies are cutting budgets, paring costs, slowing down projects and postponing new ones.
Saudi Arabia is hoping lower prices will stimulate economic growth and demand for oil. In the meantime, Saudi Arabia and the Persian Gulf emirates can afford to wait.
That is not true for many of the other oil exporters. Venezuela is highly vulnerable to turmoil and even financial collapse. Russia is coping not only with lower prices for oil, which provides over 40 per cent of government revenues, but with Ukraine-related sanctions, and seems headed into a deep recession.
Nigeria, the largest economy in Africa and the continent’s most populous nation, is also at risk.
Over all, the fall in oil prices could mean a $1.5 to $2 trillion transfer from oil-exporting countries to oil-importing countries. Japan will be a big beneficiary. So will China. American consumers will benefit, too, though it will also mean that fewer oil wells will be drilled here, more rigs will be laid up and increasing numbers of workers will be let go.
American shale oil has become the decisive new factor in the world oil market in a way that could not have been imagined five years ago. It has proved to be a truly disruptive technology.
Oil is now below $50 a barrel, a price too low for a good deal of the new shale oil development to make economic sense. Yet output is likely to continue to rise by another 500,000 barrels per day in the first half of 2015 because of sheer momentum and commitments already made.
Come the middle of the year, however, growth will flatten out. Producers will work hard to improve efficiency and lower costs, but in 2016, at these prices, American output could decline. Production elsewhere in the world will also be flattening.
But by then, the world economy might be doing better, stimulating oil demand. Prices could start rising again. If the gulf producers have their way, prices will not go back to $100 a barrel. Even at prices well below $100, American shale oil producers will find ways to drive down costs and output will start rising again. And the world’s new swing producer will find itself back in the swing of things.
(Comments by Daniel Yergin an energy expert. Printed in the New York Times & Business Standard)