Are We Ready to be Energy Independent?
Geoffrey Garrett
Dean at University of Southern California - Marshall School of Business
People were talking a lot about oil prices when I was in Texas last week, and they weren’t celebrating low prices at the pump.
The halving of the oil price in the past year puts at risk not only investment in new production, but also all the financing supporting and dependent on it—not to mention construction in Houston. In fact, low oil prices spooked the markets on Wall Street at the end of last year.
Call it the yin and yang of oil prices. Different parts of the economy are affected very differently on both up and downswings in prices.
But why did the oil price drop so fast? What will happen in the coming year or two?
I am reminded of 2 truths from economics. First, price is where demand and supply meet in the market. Second, in today’s world, markets are global.
The oil price plummeted from $100 a barrel last summer to under $50 today because supply has risen while demand has fallen—both a lot.
On the supply side, the fracking technological revolution in America that started with shale gas has now morphed into mushrooming shale oil production. After decades of dependence on the Middle East, the US will soon become energy independent where oil is concerned.
On the demand side, while the US recovery is real, there is no joy anywhere else in the global economy.
China’s annual economic growth going forward is likely to be closer to 5% than 10% and the country must tackle its pollution woes. Europe remains moribund, with the Russia security challenges only making things worse. Brazil, a natural resource superpower, has slowed down with China. There is lots of promise re middle class consumers in Africa, India and Indonesia, but much of that promise is still in the future.
So does the mean $50 oil is the new normal? Not so fast, based on what I heard in Texas where supply is concerned. Fracking produces shallow wells, with small production. To keep production going, you need to keep digging lots of new wells.
After a few years of frenetic drilling, new well construction has now essentially stopped—and that means US oil production will turn south very soon. Investment will only come back into shale oil when the oil prices gets back to above about $65 a barrel, because that’s the price at which investors can expect a decent return on their capital.
How long will it take for US production cuts to push up the price? 12-18 months seems a reasonable time line. But it could be faster if either the Saudis cut their production or if there are signs of life in the global economy outside the US.
Isaac Newton said “what goes up must come down.” Where oil prices are concerned, the reverse is also true.
Geoffrey Garrett is Dean, Reliance Professor of Management and Private Enterprise, and Professor of Management at the Wharton School of the University of Pennsylvania. Follow Geoff on Twitter.
CEO at Axibase Corporation, Forbes Tech Council Member
9 年Like like a pre-cursor to what oil majors will be doing upstream 1-2 years from now given the time lag ingrained in their decision making process. There will be cuts.
Chongqing Weiheyuan specialities CO - Executive Assistant
9 年With the development of the world we live in society would be to renewable energy development, like solar energy, nuclear power, and so on. I believe that our generation will be set off in energy-based industrial revolution.
Accelerating access to safer, cleaner and more affordable energy through efficient deployment of capital, adoption of new technologies and business transformation. Views are my own.
9 年Indeed, US light tight oil (LTO) appears to have become the new swing producer. Given the speed of industry in North America, we'll see much faster response than we did in past cycles. It is the new paradigm of unconventional resources. However, there are several other aspects to think about. First, when we talk about $100/bbl last year and $50/bbl this year are not talking about same dollars. Since July last year US dollar has appreciate over 20% against other currencies (e.g., measured by USDX). This means that for some producers who denominate their cost in local currency (e.g., Russia) the input costs have reduced. For them, the math is not as impacted as we'd initially think if we look at price decline -- segments of the supply curve have shifted to the left. Second, we should keep in mind the cycle time for other, conventional assets. Typically it takes several years to develop a large producing field, and many of these have already been funded or are even under construction. These will continue going, as the cost has been sunk and marginal revenue/cost will justify operation. So, more supply will keep coming on line. Third, we should not underestimate ingenuity and resilience of US enterprise. Year after year, unconventional players have become more efficient and effective. This came through advancements in technology, organizational models, and supply chain together. Lower prices will add pressure to continue pushing down experience curves. Finally, we should keep in mind other elements of supply volatility. For example, easing of Iran sanctions may increase global supply, while escalation of geopolitical situation may curb it. Events like these are difficult to predict. Overall, it looks like there will be a prolonged supply overhang with significant short-term volatility. Capital planning in particular will be challenging. But, as it often happens, turmoil will likely create new winners.
Senior Production Control Support Analyst
9 年E