Monday, January 26, 2015

Learning from the oil market

Learning from the oil market

The recent plunge of oil prices to below $50 a barrel offers the same lessons as previous sharp fluctuations: Energy markets work, and politicians who try to steer them almost always get it wrong.
It’s ironic that, amid this demonstration of the inexorable power of supply and demand, Congress is beginning its debate on the symbolic issue of the Keystone XL pipeline. The premise on both sides of the aisle is that legislative decisions will shape the supply of crude oil. But 40 years of experience says otherwise. 


David Ignatius writes a twice-a-week foreign affairs column and contributes to the PostPartisan blog.  
The “oil shock” aspect of price swings makes us forget that, since the 1970s, the energy market has regularly oscillated because of supply and demand. Producers once imagined they could rig this market through the OPEC cartel. But one of the biggest stories of 2014 was the stone-cold death of OPEC as a viable cartel. It turns out there are just too many producers for price-fixing to work.
What accounts for the more than 50 percent decline in oil prices since mid-2014? Economists say it’s a reaction to forces that have been building ever since the market recovered from the last price collapse in 2008, when it fell from over $130 a barrel to below $50. Spot prices surged again by 2012 to a peak of nearly $120, but this accelerated a gush of new production. That, coupled with lagging demand, made the high prices unsustainable.
The country that seems to have understood best the reality of the market is Saudi Arabia. This may surprise people who remember the Saudis as the architects of the 1973-1974 embargo. But after decades of trying to control the market by rationing production, the Saudis realized that, because their oil is so cheap to produce, they were best positioned to survive in a world of oversupply.
“Why should the low-cost producer prop up prices to keep the higher-cost producers on track?” asks Nat Kern, publisher of Foreign Reports, a leading industry newsletter. He notes that the Saudis made clear back in December 2013 that they were done with their role as swing producer.
The Saudis remain the biggest players in the market, even if they’ve learned they can’t control it for long. “OPEC may be dead, but Saudi Arabia isn’t,” says J. Robinson West, a senior adviser at the Center for Strategic and International Studies. “The moral of the story is that Saudi Arabia remains sovereign in this industry.”
This latest supply-demand turnaround began not with the oil giants but with small, independent U.S. gas producers. West notes that these “little guys” developed fracking technology a decade ago to produce gas from shale formations and cash in on what were then high prices for natural gas. Gas prices fell as supply increased, so producers turned their technology to oil, which traded at a much higher world price. Markets, not government policy, drove this activity.
The shale revolution has added more than a million barrels a day to U.S. oil production, making America an energy superpower on the order of Saudi Arabia or Russia. With the recent price collapse, some shale exploration may be halted. But a study by Scotiabank of break-even costs of major shale plays, cited in a recent post on Vox, shows that production from the Bakken fields in North Dakota and some other big shale reserves is likely to continue, even with oil below $60.
Oil became a decisive strategic commodity in the 1970s, often used as a weapon against America. But the recent price collapse seems likely to bolster U.S. foreign policy leverage. Russia and Iran, two potential adversaries, are both chronically dependent on oil exports. With falling prices, they need to expand production and exports, if possible — which will add to the global supply glut.
Nobody knows how long this market cycle will last, but economists say low prices may persist so long as the Saudis keep producing aggressively. That’s because there are so many cash-hungry producers, such as Russia, Iran, Iraq, Libya and Venezuela, not to mention the new U.S. shale producers.
Meanwhile, Congress battles over the Keystone XL pipeline. At current prices, its throughput of relatively high-cost Canadian tar-sands oil appears less attractive. But if the price is right, this oil will get to market, if not by pipeline then by rail.
White House: Obama would veto Keystone XL bill(1:14)
White House press secretary Josh Earnest said Tuesday that President Obama would veto a bill that would allow for the construction of the Keystone XL pipeline.
Congress would be wise if it took its cues from the market, as the Saudis have learned to do. Ignoring price signals is a guarantee of bad energy policy.

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