A New Oil Paradigm Shuffles the Deck

A plunge in oil prices is feeding consumer pocketbooks and reshuffling the economic and strategic cards across the globe.

OPEC’s recent decision to sustain current production levels looks like a high stakes game of chicken.  These countries produce 40% of global oil but failed to anticipate the magnitude of the U.S. production surge – up 80% in six years.  That increase is greater than the output of every OPEC country except Saudi Arabia.  And it has coincided with recovering production in some previous trouble spots just as economic activity appears to have stalled in some key corners of the world.

This is a decidedly different dynamic from the well-worn story of tight oil supplies and rising demand from China and other emerging economies.  Now exporters strategize to hold market share and see who’ll be able to keep the crude flowing if prices slip lower.  Current levels may curtail some higher-cost production, but the U.S. surge is proving resilient, and technology moves on.  The International Energy Agency (IEA) estimates that just 4% of U.S. wells need oil above $80 per barrel to be profitable.  Some sources believe most shale oil and Canada’s tar sands can be economic even if oil approaches $50 per barrel.

Meanwhile, some key OPEC members – notably Venezuela and Iran – are stressed.  Russia is not in OPEC, but oil generates 40% of its state budget.  The ruble has tumbled along with oil, boosting the cost of Russia’s heavy dependence on imported food and consumer goods.

Regions that are heavy oil importers are getting a welcome break.  This includes much of the Eurozone and Japan, both of which have been flirting with recession.  There are a number of beneficiaries across Asia, including China and especially India, which imports about 85% of its oil.  Lower prices are a timely counter to the subcontinent’s chronically high inflation and heavy government energy subsidies.

For the U.S. the broadest benefit is to consumers, but industry gets a cost break as well.  Oil and gas producers face more challenging economics, especially those carrying significant debt.  But the U.S. is still the world’s most diversified, highly integrated economy, and it’s hard to see how a big energy cost cut can be anything but net positive.

Any analysis of the new energy paradigm starts and ends with the fact that oil is, well, fluid.  The IEA pegged third quarter demand at 93.06 million barrels and production at 93.62 million – an oversupply but not a vast oversupply.  Eight years ago, with oil near current levels, we ran a piece titled Oil Prices Could Go Either Way, and Surely Will.  Since then oil has fetched as much as $150 and as little as $40.  Things change, and then change again.