Pumpjacks at work pumping crude oil near Halkirk, Alta., June 20, 2007. In a recent speech, BP chief economist Spencer Dale, a former Bank of England official, said we need a new economics of oil to deal with a world in which oil resources will never be exhausted.Larry MacDougal/The Canadian Press
They held out as long as they could, probably for too long, but this week the captains of oil conceded defeat and signalled their retreat. In a bid to preserve cash to pay its huge dividend, Shell struck a red line through more than $8-billion (U.S.) of investment as it cancelled expensive frontier projects, including offshore drilling in Alaska and the Carmon Creek oil sands project in Alberta.
If Shell can still pay a dividend, it is because of its downstream businesses of selling gasoline, jet fuel and chemicals. The collapse in oil and natural gas prices has turned into a slump, the recognition of which was acknowledged on Thursday by CEO Ben van Beurden, when he referred to the "difficult, but impactful" decision to cancel projects. Writing off investments in Alaska and Canada cost the company $4.6-billion but there was a further hit of $3.7-billion "triggered by the downward revision of the long-term oil and gas price outlook."
In other words, Shell has taken the view that there will be no recovery soon in the oil price – hydrocarbon investments made when the oil price was in triple digits are permanently underwater. Last week, BP CEO Bob Dudley announced another campaign of cost cutting and asset sales – between $5-billion and $8-billion over the next two years. The hacking at operating costs and the balance sheet is intended to get BP into shape to break even at a $60 Brent oil price by 2017.
There is no great magic to BP's implicit oil price forecast as the futures market is predicting a very slow recovery to $60 oil in 18 months time. Meanwhile, the energy giants are bracing themselves for a natural gas blowout. Wood Mackenzie, the consultancy, reckons that 130 million tonnes a year of additional liquefied natural gas (LNG) capacity will be delivered over the next five years. The oversupply will be enough to push Asian gas prices below European prices, to levels as low as $5 per million BTU (British thermal units).
Commodity price collapses tend to prompt two kinds of responses: initially, a panic by short-term players followed by a price bounce; later, and only if the collapse turns to slump do long-term players change their strategy. The oil game has now gone beyond short-term volatility and with prices moving in a narrower range, we can now reflect on the long-term outlook.
For most of the 20th century, the price of oil was almost unchanged and in money of the day it offered very cheap fuel to consumers. It only became expensive in the 1970s when the OPEC cartel began to exert a restraining influence on oil supply. The big change in the past 12 months has been the collapse of OPEC, triggered by Saudi Arabia's decision to chase market share.
In a recent speech, BP chief economist Spencer Dale, a former Bank of England official, said we need a new economics of oil to deal with a world in which oil resources will never be exhausted. He proposes four reasons for this: the lean manufacturing characteristics of shale oil, including short lead times and reusable equipment; the ability of shale explorers to respond quickly to demand signals; the global dynamics of oil trade are no longer East to West but increasingly West to East; and finally, while OPEC may still have the ability to respond to cyclical shocks, such as economic recession, it cannot prevent structural change, such as new oil technology, government policy on climate change or the electric car.
The central idea in BP's new "tool kit" of economic analysis is that oil supply is not likely to be exhausted. Inherent in much of the hedge fund speculation that drove up oil prices during the past five years was the notion that we were seeing the beginnings of peak oil. To their credit, sensible people in the energy industry never believed it. Instead they focused on the impact of soaring demand from Chinese manufacturing. This is now waning, the Chinese steel industry is close to collapse, oil demand in Europe has been shrinking for years and climate change policy is about to be squeezed tighter.
For oil exporters, this means lean years ahead; for Big Oil, it probably means a refocus on manufacturing and product marketing. But for the rest of the world it just might be good news if consumers begin to spend the energy price dividend. The slowdown in Chinese growth could be a big positive for the global economy, reckons Diana Choyleva of Lombard Street Research. She suggests that the global rebalancing that is now transferring income from commodity producers (say, in Alberta) to commodity consumers (say, in Ontario) could stimulate a "deflationary boom." If consumers in North America, Europe and Japan begin to believe that lower fuel prices are here to stay, they may start to spend the deflationary dividend and boost demand, raising economic growth.
It is a highly speculative scenario, and Ms. Choyleva admits it depends on many factors falling into place, such as a willingness by central banks to forgo further deflationary currency wars, greater confidence in U.S. households about the economy and a soft landing in China that avoids mass unemployment. These are big ifs, but the omens are not bad and China's weakening demographics suggest a tight labour market will continue. For Canadians, the idea that the world is not a place of permanently dwindling and increasingly expensive resources is a challenging one. But it is, nevertheless, a better world.
Carl Mortished is a Canadian financial journalist based in the U.K.