The collapse of oil prices which started at the end of 2014, and played out through 2015 and into 2016, took many by surprise. The IEA got it very wrong – as indeed they have repeatedly done in the past. The companies were no better, nor were the politicians who were so convinced that prices would go on upwards forever. They thought that even the more expensive renewables would all be in the money before 2020.
As the prices have come tumbling down, they have all struggled to keep up. Both the companies and the markets took the price falls to be temporary, and in the first half of 2015 they all expected a bounce back to between $60-$80 a barrel. The futures markets agreed. They then all revised down the estimates as 2015 ran onwards, but remained confident that there would be a return to high prices. Bankruptcy in the US and reducing on capital expenditure reinforced this confidence. It was all only a matter of time.
Yet it might not turn out this way. Oil is abundant and it is cheap to produce in exactly the places where output is expanding – like Iran and Iraq and even Russia. With higher output from all the main producers except the US, freezing production now would not make much difference. The world may be heading for 5 countries all producing over 10 mbd eventually – the US, Saudi Arabia and Russia, joined by Iran and Iraq.
The supply side looks robust, whereas demand is anything but. The slow down in China is real, and no amount of official Chinese statistics can disguise the scale of the contraction. The weak global demand for commodities may turn out to be much more normal than what went on at the end of 2014. Further out the demand side looks vulnerable too. Oil is used primarily in transport and petrochemicals. In both cases gas is snapping at oil’s heels, and gradually electric cars and lorries, and new materials will make a further dent in oil demand. Add in the digitalisation of manufacturing and services (robots, 3D printing, and AI) and the growth of electricity is likely to surprise on the upside. Oil plays little part in electricity generation. The digital revolution might continue the decline in world trade too, and production is re-shored, reducing the global transport demand further.
The new normal will take a while to sink in. But when it does, the profound structural break with the past in oil markets will reveal itself.
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