Black Gold…or Fool’s Gold?
For longtime students of oil markets like Christof Rühl, it sometimes seems like the energy world has been spinning around like a drill bit. Rühl, the head of research at the Abu Dhabi Investment Authority (ADIA) and chief economist at BP, finds the current conversation regarding energy is no longer only about supply but also lack of demand; not about “peak oil” supply but rather so much abundance that the world is running out of storage space; not about prices that are too high but prices being lower for longer; and not about U.S. energy dependence but rather the U.S. using what President Donald Trump calls a “dominant force” in negotiations with other nations regarding market share. And what’s more, over the last few weeks all these landmark developments have been the canary in the coal mine as the world got caught up in a devastating pandemic that has unleashed a severe global economic downturn.
Rühl, who is currently a Senior Research Scholar at Columbia University’s Center on Global Energy Policy and a Senior Fellow at Harvard’s Kennedy School, says, “The virus has accelerated trends that were already here and were already visible.” For example, while oil production was climbing to new highs, energy demand was slowing. And now, thanks to COVID-19, demand has fallen off a cliff because much of the world’s industrial production was shut down, and especially because lockdowns mean there’s far less commuting to work, or recreational driving.
The oversupply had already led to an historic oil price war before the pandemic was recognized, in response to Saudi Arabia seeking to cut production to bolster prices but Russia walking away from that deal. Efforts to reach an agreement were not going anywhere but then that battle was “overwhelmed by the impact of the coronavirus,” according to Rühl. Moreover, the delicate mating dance of output management, often orchestrated by the Saudis, worked fairly well for years, but more recently, the rise in U.S. shale oil production has changed the dynamic, Rühl says: “Every time OPEC tried to cut production to reap the benefits of higher prices, this triggers production in the U.S., and so the market share of the U.S. has increased.”
Oil prices, which were around $61 a barrel in December, went into free fall in recent weeks, and at one point in April, the price of one oil benchmark dipped below zero, meaning some holders were ready to pay people to take the oil off their hands. Saudi Arabia needs oil at about $80 a barrel to finance its budget and the much-touted efforts to diversify its economy, and Vladimir Putin needs at least $40 a barrel to maintain Russia’s standard of living.
Energy stocks and energy partnerships have been a focal point for many major investors. But at recent oil prices, Rystad Energy, a consulting firm, estimates that about 70 deeply indebted private U.S. oil producers are at risk of bankruptcy. Meanwhile, a number of key state oil producers around the world, including Nigeria, Algeria, Iraq, and Iran are said to be seeking assistance from the IMF. And Mexico’s Pemex and the Venezuelan oil industry are also deeply troubled. Rühl says they all have gradually become bystanders, more subservient to the increased concentration of production and to decisions made by the big three producers – Saudi Arabia, Russia, and the U.S. – which together account for about 40% of global oil production.
As all this unfolds, Rühl says, “The U.S. has slowly but surely become the beneficiary of the oil world before the crisis.” An increase in prices ramps up shale oil production in the U.S. Lower prices, of course, drive out the marginal producers but benefit some American consumers. As a result, “Trump found himself in this position where he wanted prices to be not so high as to upset his voters but not too low to destroy the industry.” But Rühl thinks that regardless of strategy, while specific shale operators may shut down or go bust, the assets are there, and newcomers will be able to restart quickly.
Rühl says the energy discussion has changed in other ways as well. First of all, he notes, “The role of oil in the economy per unit of output has declined.” Thirty years ago, it took ten liters of oil to produce $100 of global gross domestic product; now it takes only seven liters. So, the price of oil isn’t as critical as it used to be. Meanwhile, the once burgeoning political opposition to fossil fuels may become more muted amid a global recession. “I’m not very optimistic” about renewables if we enter a global recession, Rühl says, because the “economic crisis” makes the case less salient. “Four months ago,” he adds, “everybody was talking about sustainability and governance. Have you heard any talk of ESG lately? Almost nobody mentions it.” In Abu Dhabi, where he has been quarantined, typically people’s attitude is, “I’m worried the air conditioning may not work. I’m less worried whether it is powered by solar or nuclear at this point,” he says.
Rühl thinks oil prices are destined to stay low, and he says he’s a bit perplexed by the hand wringing in many quarters about this: “If the economists are right, and we are entering the mother of all depressions, in that situation, you need lower oil prices, and it’s a complete mystery to me that many analysts have decided that the fall in oil prices is bad.”
Christof Rühl is a member of II Network, to discuss the content of this article and further engage with him, comment below.