First oil

“We have met the enemy and he is us.”—Cartoonist Walt Kelly through comic strip Pogo.

WTI crude oil below $50/bbl has turned the global economy upside down. The low crude oil prices are a boon for oil consumers throughout the world, including China and India. These countries were bleeding cash from 2010 to 2014, with triple-digit crude oil prices. Now, China’s storage tanks are bursting at the seams with cheap crude oil. India has achieved three quarters of surplus balance-of-payments, due to a significant drop in the import bill. Refiners and petrochemical companies are enjoying low feedstock prices. Drivers throughout the world are making lower payments at the petrol pump.

On the supply side, the oil-producing nations, companies and employees are facing devastating economic prospects. According to a BBC analysis, Russia loses $2 billon every time the crude oil price drops by a dollar. Venezuela is enduring an inflation rate of 60%. During the past year, oil and gas operators, and service companies, have laid off more than 176,000 employees. Some oil companies are selling off their distressed properties to maintain cash flow.

Yet, there are few signs of a drop in worldwide oil production to close the gap between supply and demand that is now pegged at about 2.5 MMbopd, an increase of about 1 MMbopd since six months ago. According to Bloomberg, production in Saudi Arabia, Iraq and Venezuela is at or near the highest level in a year. Russia increased its output 1.3% over the last year and is pumping 10.6 MMbopd. U.S. production has dropped only slightly to 9.3 MMbopd from the June peak of 9.6 MMbopd. Ed Morse, head of global commodity research at Citigroup Inc., suggests that oil must drop below $30/bbl for output to start declining, Crude oil inventories in storage tanks throughout the U.S. remain about 90 MMbbl above the five-year average, according to the U.S. Energy Information Administration. The storage level at Cushing, Okla., itself, was at 57.7 MMbbl.

The rationale given for this irrational behavior is an effort to maintain cash flow, regardless of the price. For Saudi Arabia, cash flow is not a concern, but the Kingdom is intent on waging an economic war against U.S. shale producers, whom it expected to succumb when the crude oil prices dropped below $60/bbl.

David Pursell, global oil analyst for Tudor Holt & Pickering and member of the World Oil editorial board of advisers, put it succinctly in a Houston Chronicle article, “With prices at these levels, the industry is broken.”

What’s the fix? Ideally, producers throughout the world should reduce total crude oil production by 3 MMbopd. According to the International Energy Agency, supplies outside OPEC are expected to contract in 2016 by only 200,000 bopd. What we need is an alliance of major oil producers to accomplish a proration that the Texas Railroad Commission enforced in the 1920s. Geopolitics makes this simple economic goal virtually unattainable. An us vs. them attitude prevails between Saudi Arabia vs. Iran, Russia vs. U.S. and Europe, etc. We’re destined to suffer through this prolonged downturn before demand exceeds supply.

There were some encouraging shifts in early September. The crude oil prices shot up by about $10/bbl on the basis of several news developments: EIA reported a drop in U.S. crude oil production, and both OPEC and Russia indicated a willingness to lower their output.

Could we benefit from some political leadership at this stage? Unfortunately, U.S. President Barack Obama is in La La land, ignoring the big picture and putting his energy into renaming a mountain and accusing the Koch brothers of working against the solar panel industry.  

About the Authors

Pramod Kulkarni

World Oil

Pramod Kulkarni pramod.kulkarni@worldoil.com