“Wake” is a weekly foreign policy broadcast produced by Talk Media News and hosted by Luke Vargas from our studio at U.N. Headquarters in New York.
The following is a complete transcript of Episode Four, “How Cheap Oil is Changing the World.”
Luke Vargas: On today’s show we’re looking at how cheap oil is changing the world. The days of $100 a barrel oil are over. Since 2015, prices have hovered around $50 as oil producers keep on pumping, often in a desperate bid to support government revenues. The new price landscape spells ruin for some, but opportunity for others.
How is cheap oil affecting life in America? What does it mean for the future? For the fight against climate change?
We’re taking on those questions next, on Wake.
We’re coming to you today from U.N. Headquarters in New York, and we’ve put together an all-star panel of experts here in the U.S. to talk about global oil.
But before we turn to them, joining us on the line from Oslo tonight is Thina Saltvedt, chief analyst for Macro Oil at Nordea Markets.
Thina Saltvedt: Thank you.
Luke Vargas: You’ve got a broad, international view of oil markets as they stand right now. Give us the lay of the land on prices and on oil producer sentiment in May of 2017:
Thina Saltvedt: Let’s start with the price, and we can start with the American reference price, which is West Texas Intermediate. Today it’s around $45 a barrel.
What is happening at the market at the moment is a tug of war between the OPEC cartel – which accounts for around 40 percent of the world production of oil – and the American shale producers. We’ve had a period now for around the last two years, from around July of 2014, with the oil prices starting to move down sharply. And the main reason for the fall was a lot of production coming out from the U.S., the shale producers have turned on the taps, so we see lots of oil coming up.
I think that really surprised the markets, how fast they could increase production and how fast it went out to the market. So in order to not lose too much market share the OPEC cartel, which is mostly the Middle East producers, they wanted to fight back to keep their market share. And what they did was to flood the market with cheap oil.
That turned out to be an oversupply, so now the market is oversupplied with oil, it’s far too much oil out there and that keeps the oil prices low. So what they’re trying to do at the moment is to cut down on the inventories, to cut down on production.
The OPEC cartel actually decided at the very end of November in 2016 to try to push up prices again. They cut back on production. And that actually worked. They managed to push up oil prices until about $50 per barrel.
But it didn’t last for very long, because when oil prices started to move up, the very efficient U.S. shale producers started to turn up the taps again and now we see a lot more oil coming out from the U.S., and that makes it more difficult for the OPEC cartel to balance the market, to get oil inventories down to more normal levels. And that is what the whole tug of war is about at the moment.
Luke Vargas: Thina, I follow you on Twitter, and I must say, unlike a lot of oil analysts who I’ve spoken with, oil is far from the only energy form that it seems like you’re interested in. You’re sharing stories about how clean energy jobs are replacing coal jobs, electric vehicles in China, a bullish outlook on global wind energy production.
Do you see this commodity, oil, losing its central global importance anytime soon? Or is it going to be relatively the same industry we’ve known, just maybe with some new players in it like the shale producers in the U.S.?
Thina Saltvedt: Yes, you’re absolutely right. I think we’re going to see a big change in the oil market. Not today, not tomorrow, but in the next decades.
What we’re seeing going on at the moment is industrial revolution. New technology is coming on line. For example, electric cars, electric trucks. We’re seeing the cost of producing, for example, wind power or solar panel is falling sharply. The same with the electric battery – the cost of producing them are falling sharply, as well.
In addition, we’re seeing that the big climate changes are starting to affect us much more than they did before. So we need to change, and we’re seeing that green energy start to get much more competitive that it used to be.
And we can also see, for example, big investor funds especially in the U.S. are starting to focus much more on what is sustainable, what is sustainable energy, what is clean energy – to try and reduce CO2 emissions and start to avoid the climate changes before they really affect our lifestyle.
So I think, actually, before the end of the next decade, big changes in the industry, especially in the transportation sector which accounts for around 55 percent of the total oil consumption in the world, will change a lot.
For example, we have electric cars as I said, but also trucks, but also boats coming online, ships. You’ll see things like 3D could actually change our transportation sector radically within the next 15 years.
So I think we will reach a peak in oil demand before the end of the next decade, before 2030. And that will change the whole business in the oil industry and the price-setting mechanisms a lot within the next 15 years.
Luke Vargas: Thina Saltvedt, chief analyst for Macro Oil at Nordea Markets, calling us from Oslo tonight. Thina, thanks for staying up late to talk to us.
Thina Saltvedt: Thank you.
Luke Vargas: Let’s pick up on that with two oil experts here in the United States.
Morgan Downey is author of the book, “Oil 101,” and CEO of Money.Net. He was also, formerly, the Global Head of Commodities at Bloomberg, LP. Morgan, welcome to the show.
Robert McNally: It’s great to be with you. Thank you, Luke.
Morgan Downey: Thanks. Thanks for having me.
Luke Vargas: And also with us from the nation’s capital is Robert McNally, author of the great new book, “Crude Volatility.” He’s the president of the Rapidan Group and a former presidential advisor. He was George W. Bush’s top council on international and domestic energy from 2001 to 2003. Bob, so great to have you. Welcome.
Luke Vargas: Thina just described a bit of the recent history of oil – some panic among OPEC nations as U.S. shale challenges their dominance.
Bob, your book, “Crude Volatility,” tells a much longer history of oil. Could you zoom out a little further and put some of these recent developments into historical perspective?
Robert McNally: What’s not new is that since the beginning of the oil industry we’ve had a problem of either too much or too little – as economist Myron Watkins said in 1937 – gluts or famines. And these have triggered wild oil price swings.
And so through history we’ve seen groups of producers or government officials step in and regulate let’s call it ‘short cycle oil,’ or that oil supply that you can turn on or turn off relatively quickly, within days or weeks.
John Rockefeller did that indirectly by monopolizing refining, including with transportation. The Texas Railroad Commission was perhaps the most effective oil supply regulator the world has ever seen and brought us stability for 40 years, from the early 1930’s to the early 1970’s.
And so OPEC tried to follow in the footsteps of the Texas Railroad Commission, but it’s proved much less effective.
What we’ve see now over the last 10 year, and what we’ve seen before, is when the market needs that regulator, needs a producer to step in and either shut off or turn on quickly-available oil, and doesn’t have one, you start to see either inventories deplete and prices soar – which we saw 10 years ago, a near quintupling in peacetime, which is unprecedented really since the 1970’s – and when you have too much oil and no one is willing to cut back, inventories build and the price collapses, as we’ve seen since 2014, a 75 percent collapse down to $26 a barrel last February.
We just don’t see that type of normal thing when there’s a healthy and effective regulator, and so I think in a nutshell what we’re seeing is an oil market that needs that type of swing producer – probably because of shale, as the previous interviewee mentioned – and doesn’t have one.
OPEC is unable, and unwilling in my view, to play that swing producer role, and I don’t think that’s going to change in the near future. And we ought to get used to these kind of roller coaster oil prices that we’ve seen in the last 10 years.
Luke Vargas: Morgan, Bob and Thina have both talked about the emergence of shale oil. What’s the economics of this kind of driller? Where has it been occurring? Why is it so revolutionary?
Morgan Downey: There’s a spectrum of costs of oil production in the U.S. You will have some oil fields in the U.S. where it is $10 a barrel to produce, but it might only produce a couple of hundred barrels a day, and then you might have some oil wells in the U.S. that are very deep offshore that cost $50, $60, $70 a barrel and that are actually currently losing money or are shut in.
Before 2009, 2010 fracking – which is the process called hydraulic fracturing, where water is pumped into rock where the oil reservoir is and it tries to crack the reservoir open, if you will, to kind of unlock that oil – that was a very expensive process and that only became profitable above $50 oil, which started to be the case in the markets starting around 2008, 2009.
And so the oil industry has gone to these two locations where there’s this rock or oil reservoir which is suitable for fracking. And these are in North Dakota, very isolated parts of America, and West Texas. And over the last five, six years a huge amount of drilling, but also a huge amount of technology and innovation has gone into unlocking oil in this new process. It’s a very expensive process, fracking. It requires oil to be $50, $60, $70, $80 a barrel depending on how close the oil well is to the pipeline and various other factors.
It’s had a little bit of a snafu over the past few years with the collapse in prices about a year ago. North Dakota and West Texas were hit quite severely just economically as a result of that collapse, and now they’re tending to recover economically again, with the kind of slow creep up in oil prices up to almost $50.
Luke Vargas: So Bob, I want to look globally here. We see shifting production here in the United States. How is this happening around the world?
I remember back in 2008 when oil was really expensive, $147 a barrel, there were stories about exploratory drilling in the Arctic, going to the far corners of the world. Is that still occurring? And if it’s not, what are the consequences of that long-term?
Bob McNally: Well you know, after 2014 when OPEC decided to let the price drop and hopefully sort of set back U.S. shale production, what we saw is Saudi Arabia and Russia and Iraq and other producers sort of went full-throttle. So much so that by the end of last year, October, you had record production levels in Saudi Arabia and Russia, and Iraq was peaking after its disruptions.
So you had sort of a surge of oil outside the United States. U.S. oil production peaked in April of 2015 and then fell back to about 8.6 million barrels per day last September and has come back pretty strongly since then. So the world world of went on a tear after OPEC let the price drop and assumed that shale would slow down.
This lead to a concern that there was too much oil in the world, that inventories were too high. So some of the OPEC producers and Russia, and a few countries outside of OPEC, got together and said, well, we’ve all had good fun here going max, but we better tamp back a little bit or prices are going to drop like they did to $26 a barrel last February. And so we’ve seen producers come off a little bit, slow down a little bit, from those record high production levels of late last year.
But the question really is, is that enough to start draining these toweringly high global oil inventories? And as the price behavior shows in recent days there’s now doubts about that creeping in.
I think that sort of explains the trend here. You saw the U.S. set back temporarily but it’s now charging back. And the big producers outside the U.S. who sort of went full-throttle have tamped back a little bit, but have they tamped back enough and do they have to cut some more to keep prices from collapsing again?
At the end of the day we’re still dealing with this glut of oil that developed after 2014 and having trouble working it off.
Luke Vargas: Bob, let’s talk about some of the countries around the world that really depend on the sale of oil to sustain budgets. The Saudis need, I think, $80 a barrel to balance their budget. The numbers are even higher in Iran or Venezuela, Russia. How are these countries coping with this economic reality?
Bob McNally: Well each country is dealing with it based on its own peculiar circumstances and capabilities, but all of them are suffering in one way or the other.
So take a country like Saudi Arabia. Now Saudi Arabia had used the good old days of $100 a barrel to sock a lot of money away, and they’ve been running down their foreign exchange reserves, some $200 billion. Now part of the that was to pay for the Yemen war, but they sort of saved for a rainy day, the rainy day has come and they’re running down their foreign exchange reserves.
They also have cut subsidies, although they recently restored them. But they’ve cut some spending.
Then take a country like Russia, which decided that it did not want to run down its foreign exchange reserves, so it devalued its currency by 40 percent, imposed enormous costs on its consumers, but it kept its foreign exchange reserves from collapsing.
And by devaluing its currency it lowered the cost of production in Russia to the degree that production there, partly at least, is Ruble-denominated. So that’s why Russia was able to surge its production even after prices fell.
Now then you get a country like Venezuela, which was on the edge even before prices fell from $100 a barrel, well they’re running out of foreign exchange reserves, they’ve fallen from $66 to about $15 billion. And they’re collapsing and they’re running out of the ability to import food and other materials, and so there you’re dealing with almost societal instability, and order is being maintained by folks with guns.
And so countries are dealing with it differently, it’s been very very difficult. They all want to get out of this as fast as possible – those towering oil inventories and the risk of another oil price collapse and prolonging this hemorrhaging – because no matter what strategy they’ve chosen, they’re all painful. They want out. All producers want out.
But the question is are they willing to cut and cooperate collectively? What we’ve seen since the beginning of the oil market is that it’s very difficult to get producers to cooperate collectively to restrain their production. The temptation is to cheat, to let somebody else do some cutting and you enjoy the higher oil prices. This has always been a challenge for the oil industry.
Luke Vargas: Morgan, what do U.S. oil companies think about cheap current prices? I can’t imagine the prices are helping their bottom lines, but have they come out of this period better off in any ways? Has cheap oil maybe prevented consumers from buying electric cars or changing consumption habits?
Morgan Downey: So U.S. oil producers have become much more efficient over the past four or five years. It used to require $75 to $80 a barrel to frack an oil well – and these are just rough averages – now it’s come down to $55 to $60 as a rough average in terms of efficiency.
So a lot of new technology has been applied, as well as new techniques. So the U.S. oil market, just like any free market environment, it’s become a lot more efficient to adjust and normalize to the oil prices.
In terms of electric cars, the oil industry really doesn’t care about electric cars. I know it gets a lot of hype because of Tesla and Elon Musk, but the electric car industry is still a fraction of a fraction of global oil sales.
This year in the U.S. auto sales are meant to recover back up to almost 19 million units, 19 million new vehicles will be purchased in the U.S., and of those 19 million only around, I think it’s something like 50,000 will be electric vehicles.
Oil is primarily a transportation fuel. It’s not used at-scale for anything like electricity. It’s too expensive to be used for electricity. Electricity is coal, nuclear, natural gas, all these very cheap fuels, including a little bit of wind and a little bit of hydro.
If you’re buying a Tesla today, effectively you’re making the statement that you want to burn coal in the U.S., and pretty much in many other countries around the world.
At the margin, yes, there is some wind production coming on the line, and it’s a highly volatile source. But electric vehicles do not really register in any oil company’s five-year plan or even ten-year plan. It’s just too far out technology-wise. And mainly because of the scale, the scale of the oil industry is tremendous, and to offset that with electrical production, there’s not enough rivers to be dammed. It would require a huge amount of scale that we’ve never witnessed before of solar or wind production.
And so the oil industry pretty much ignores electric cars right now. Sure it’s innovative, but it’s not viewed as a threat by any stretch.
Luke Vargas: And a question for both of you. If I’m hearing you correctly it sounds like there are some changes afoot in the global oil sector, but the industry isn’t going away anytime soon. But I’ve got to ask: could something happen that would really hurt the oil industry in the long run, something that may not be likely, but if it happened would really change the game?
Bob McNally: Yeah. Let me say I want to agree with Morgan and what he just said is really important, and I think it reflects the consensus of serious energy experts and oil forecasters, the IEA and others, including folks that would like nothing more than to get off of oil. But because of its enormous advantages as a transportation fuel, and because of the investment in the infrastructure, again that Morgan mentioned, it’s just impractical to think, in the coming decades even, that we will see a getting off of oil in transportation. It’s just very unlikely.
That being said, you asked about what could change things long-term. Sure. Look if somebody comes up with a battery that can hold and discharge a lot of power and when put into a vehicle can provide the same range and capability that the consumer enjoys now from an internal combustion engine, when that battery is available, I think we’ll be half the way there.
The other half of the way there, and again as Morgan mentioned, we have to generate the electricity in a way that’s affordable and that’s sustainable – if we can figure out how to make hydrogen out of water economically, or something like that. If we have a technological breakthrough that really offers us what we don’t have now. And that is a scalable, affordable, abundant form of energy that could compete with oil in transportation. I think you’re looking at some new energy form and some sort of new energy machinery like a battery to do that.
And again I want to emphasize that as much as I think we’d all like to see that soon, that is probably decades, many decades away.
Luke Vargas: Morgan, any long-term parting thoughts you’d like to leave us with?
Morgan Downey: I’d say, too, if you’re an oil consumer – which pretty much everyone in the developed world is, and even in the developing world – don’t get used to $50 a barrel, or even the current price at the pump, over your lifetime.
As in, this will last for three or four years maybe, but the longer-term trend is that oil is becoming much more difficult to find over time. Eventually, fracking will be exhausted, we’ll have to move into the polar regions and ultra-deep offshore and that requires even higher oil prices to get supply out of that.
So this is short term. For three or four years we’ll be stuck in this $50 range. But over the next 10 or 15 years I think we’re going way back over $100 yet again.
Luke Vargas: Morgan Downey, CEO of Money.NET and a former commodities trader. Author of the great book, “Oil 101.” Thank you so much for being with us.
Morgan Downey: Thanks Luke.
Luke Vargas: And Robert McNally, author of book, “Crude Volatility” and president of the Rapidan Group. Thank you for being here as well.
Robery McNally: Thank you. Enjoyed it.
Luke Vargas: If you like what you just heard leave us a review on iTunes or follow the program on Twitter @WakeOnAir.
I’m Luke Vargas, signing off. Join us again next week on Wake.