The writer is managing director of IPD Latin America, an energy consultancy focused on Latin America.
While global markets have taken a thrashing, oil remains a ticking time bomb for both the energy industry and the global economy. With no solution for rapidly depleting world storage capacity, volatility and uncertainty are likely to be the new norm in the near-term. It is imperative to consider adopting a new model for the oil market.
Opec and Russia signed a historic agreement last month to cut just under 10m barrels a day — about 10 per cent of global supply. But despite the West Texas Intermediate benchmark price turning negative on the May future contract, the wider market hardly moved as the deal did not alter the massive supply overhang that is building.
The Covid-19-induced collapse in oil demand presents a black swan, which an inelastic industry is incapable of addressing. Although falling prices are having some impact, only widespread forced production shut-ins will permit a slow return to market equilibrium. But shutting-in is not as simple as turning off a tap, due to the risk of well damage or pressure loss. So few companies want to cut production, many believing they are protected by low production costs, hedges or guaranteed sales.
With the US capable of supplying nearly 100 per cent of its total oil consumption, it holds more negotiating clout than even a few years ago. Some of this influence was seen in President Donald Trump’s latest interventions in the price war between Saudi Arabia and Russia, as well as brokering an agreement with Mexico,which had been unwilling to cut its full share of production as part of Opec+.
But the US has still not really flexed its muscles as the world’s largest crude producer. The current administration has relied on sanctions and tariffs as its preferred methods of re-establishing market balance, which are again being advocated by some American producers. Such measures, though, are unlikely to resolve fundamental market distortions. Instead, we need to consider reverting to natural regional markets or highly focused trading blocs.
Smaller blocs would be better able to handle supply-demand issues. The parties involved would also be more likely to have their mutual geopolitical interests reliably aligned. Most importantly, this would help reduce the volatility that is having a distressing impact on markets and end consumers alike.
There is a litany of challenges that would need to be addressed, including unwinding current hydrocarbon value chains and arrangements, identifying benchmark crude blends, ensuring sufficient refinery capacity and configurations, market regulations and how excess capacity would be handled. But not exploring replacements for a model that is outdated, does not contribute to global economic stability and is not viable for the future is no longer an option.
With the energy transition in full swing, Opec’s influence is on the decline. As a broader array of economically viable and less price-volatile energy sources and technologies continue to emerge, this dynamic will only become more pronounced. End consumers will be the winners, and oil supply and prices will have to become more predictable.
The reality is that in stark contrast to past fears of peak oil, the world is able to produce much more oil today than it can possibly consume. Based on International Energy Agency data, oil demand will continue to increase over the next couple of decades but then start to decline as energy transition and efficiency take greater hold.
Opec-orchestrated co-ordinated cuts and production tweaks will no longer be able to maintain sufficient market equilibrium. Many of the cartel’s members have consistently struggled with quota compliance, and the intrinsic problem of countries’ high dependence on state-owned companies’ crude oil production to support the lion’s share of their economies is destined to worsen in a global downturn.
Saudi Arabia’s decision in March to kick off a supply war and flood an already oversupplied market gave little confidence that global accords and alliances are the proper vehicles for the future. Markets need more predictable and less volatile mechanisms to deal with what lies ahead.
The breadth of global economic damage inflicted by crude oil-price volatility can no longer be tolerated. Relying on mechanisms that fail to provide economic or geopolitical stability is no longer an option. The clock is ticking on the conventionally held wisdom.
