You have not heard from me for a while. In part, because we are busy preparing a new Energy Outlook, this time out to 2035 (and to be launched on January 15, 2014). But to some extent it was also because we are trying to get our heads around the potential global implications of what we are seeing in global shale oil and gas developments, based on last year’s Energy Outlook.
The result was a somewhat lengthy write-up.
To make this more digestible, I will publish it in instalments. There is a first part, setting the scene, and then five parts dealing with five likely global implications: (i) on global oil and gas markets; (ii) on a new role for local policy; (iii) on the geopolitics of energy; (iv) on the global economy; and, last but by no means least, (v) on the environment.
And so, building on yesterday’s "Setting the scene", this is part 2; on oil and gas markets.
Pressure on the configuration of oil and gas markets
One of the first questions raised by the shale “revolution” will be about the impact of rising shale oil (and gas) production on markets and prices. Let’s concentrate on oil. In a normal market, prices should fall and the only issue for an economist would be to calculate how fast and by how much. But the oil market is not exactly ‘normal’: It features a producer cartel with a long history of trying to manage prices and production. In oil markets, the question of the consequences of higher (shale) oil supplies seamlessly translates into the question of how OPEC is likely to react.
There are good reasons to presume that OPEC members are willing and capable to react with production cuts to rising non-OPEC supplies.
Production cuts, in turn, lead to spare capacity. The build-up of spare capacity in OPEC countries required to neutralize the additional supplies (including biofuels and oil sand production) is substantial indeed: Taking our conservative production profile as a guide, spare capacity to accommodate the new supplies will have to exceed 6 million barrels per day (Mb/d) within this decade - the highest since the late 1980s, as shown on the right hand chart below;
This will be no easy task for OPEC. The cohesion of the organisation is the key uncertainty, especially in the current decade. It will be a world in which Russia, the US and Saudi Arabia account for a third of global production. Of the three, only OPEC member Saudi Arabia is likely to incur the cost of maintaining large amounts of spare production capacity. And Saudi Arabia is situated between Iraq, an OPEC member with steadily rising output but without a quota agreement, and Iran, for which no one can predict how long the current sanctions will limit production.
On the other hand, we are unlikely to witness the return of the very low oil prices last seen in the 1990 or 1980s (assuming OPEC stays put). Tight oil production is not only relatively expensive; with its high well density, it is also eminently scalable (different from the conventional supplies in Alaska or the North Sea added in the 1980s). Supplies will react if prices fall substantially.
In the first instance, the advent of shale oil (and gas) is likely to put pressure on prices by stressing the configuration of markets as we know them. In the case of oil, OPEC is the lynch pin of these markets. In the case of gas, it is the oil indexation of gas prices.
(Top image shows the two chief negotiators, Jamshid Amouzegar for OPEC and Lord Strathalmond for the oil companies, shaking hands after signing the Tehran Agreement in February 1971. Courtesy BP Archive)