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Oil Wars – Short term pain, long term gain

If the oil analysts are to be believed, Saudi Arabia and other leading OPEC oil producers are a powerful lot. They deploy their power, strategy and cunning to undermine the US shale, oil (and gas) boom, weaken Iranian hopes of higher oil revenues, knock out other higher cost production round the world, including Russia. This, somehow, will allow them to regain control of the market. And that in turn leads, at least from their perspective, to optimism that a return to much higher prices is not too far away.

Yet it is doubtful that such power in Saudi hands exists. Any cut they now attempt in production, any price boost, will immediately be met by thousands of small US producers moving back into production, taking Saudi market share, reducing, not increasing Saudi revenues. The oil supply pattern has become highly elastic in a way never before experienced. In fact, Saudi for the time being has no room for manoeuvre and no choice in the matter. Eventually, perhaps – and it could take years – all the higher cost producers will be driven to the wall and OPEC and the Saudis could regain control.

The other fading hope of the oilmen was that soaring Asian demand for oil would, by easing the world surplus, return higher oil prices. But China’s current slow down shows signs of being followed elsewhere in Asia, and as already in the West – towards a more restrained oil thirst and the decoupling of oil demand from economic growth. Even Japan’s enormous current oil and gas import need could rapidly shrink as the country returns to civil nuclear power.

On top of these oil woes most of the world’s governments have declared war, at least on paper, on all fossil fuels in the name of climate concern. In practice, the great low carbon transformation of the world energy system is turning out to be far more expensive, disruptive and painful, and will take far longer, than the climate crusaders, with their talk of a cheap transition, airily promised. Eventually, however, renewable costs will come down and permanently eat further into oil demand.

Barring a worst case scenario of some sudden ‘high impact’ event or major terrorist attack causing a momentary price spike, very weak and highly volatile oil prices are here to stay for a long time ahead. We are firmly back to the world of ‘too much oil’.

The political consequences of a prolonged cheap oil prospect are immense, for consuming and producing countries alike.

For consumers across the world the effect is the same as a tax cut. But for big consuming countries who are also producers the effect is two edged. In the UK North Sea oil and gas operations have taken a big hit just when the whole North Sea saga is entering its end game. It is estimated that between 12 and 24 billion more barrels of oil still lie beneath the UK Continental Shelf, and some gas. But it would come at a price – probably needing major tax breaks and incentives to make it economic. The pressures now on the Government to ‘do something more’ will increase. Already concessionary tax gestures have been made but more will be needed, including not just lower tax rates but more help in decommissioning huge but redundant North Sea structures and plugging exhausted oil fields. And, however skillfully this may be managed, it is impossible to ‘buck the market’. A prolonged low oil price means North Sea field closures and big job losses. Britain’s oil supply industries must also find new customers overseas. But consumers will be and feel richer every time they fill the tank. And they’ll have more to spend elsewhere.

In the end, although not before some awkward and painful re-adjustments which sensitive policy should aim to cushion, rather than resist, greater economic growth will far outweigh the disruption of cheap oil.

 

Lord Howell of Guildford

David Howell was Member of Parliament for Guildford between 1966 and 1997 and was ennobled on his retirement from the House of Commons. He has held numerous position in government, including Secretary of State for Energy (1979-81), Secretary of State for Transport (1981-83) and Minister of State at the Foreign and Commonwealth Office (2010-12). For Politeia he was author of Britain and Europe: The momentum for European Reform (2014).

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