Oil consumers have been grappling with short-term market challenges. The release of strategic stocks by the US and some collaborators is one of the biggest tools in a pretty empty box. But as well as attending to immediacy, they need to think differently about the long term.
Last Tuesday, US president Joe Biden announced the release of 50 million barrels of crude from the country’s strategic petroleum reserve (SPR). Unusually, this was combined with promised provisions also by China – despite other rivalries with the US – Japan, South Korea, India and the UK.
It is hard to disentangle the effect of the strategic stocks release from other market volatility. Prices had been dropping since October 26, partly over chatter about a possible SPR release, but more because of concerns of interest rate rises to stem inflation, and fears of renewed coronavirus lockdowns in Austria and other European countries.
When the announcement was made, prices actually rose more than $2 – the size of the release being less than expected, some representing existing commitments, and much of it representing borrowing that will be returned to the SPR later.
Yet on Friday, oil prices tumbled, down more than $8 on the day, because of the emergence of the threatening new Covid variant, Omicron, in southern Africa.
Opec+ will take these contending factors into account at its meeting on Thursday. The drop in oil prices combined with the SPR release will bolster its feeling that it has done the right thing in bringing back production very cautiously. The Biden administration should remember that, as former US defence secretary James Mattis was fond of pointing out: “The enemy also gets a vote.” Not that Opec+ and consumers are enemies – but the producers’ group is entitled to respond to actions from other market players.
Not just Opec+'s own estimates, but those of the US’s own Energy Information Administration, suggest the market will be back in surplus in the first half of next year. Holding back on its next planned monthly increase of 400,000 barrels per day, though, without waiting to see what the SPR action does to the December balances, might seem unduly provocative.
The SPR issue is interesting for what it shows about the limited options of oil-consuming states. If the sale misfires, Mr Biden could suspend US oil exports – and thereby usher in chaos in the world market and in American domestic refining. This could paint the US as an unreliable supplier and probably raise prices at the pump rather than lowering them. Beyond that, Mr Biden has few short-term options.
The longer-term dilemma for climate-conscious oil consumers is this: a world of shrinking demand will inevitably have lower diversity of supply because high-cost producers will be driven out and some countries and companies will give up new exploration, or even production, because of environmental policies.
That is already seen in the Beyond Oil and Gas Alliance, founded by Costa Rica and Denmark, that is now, with the adherence of France and a few other countries, committing to stop petroleum extraction entirely.
Costa Rica is not a producer anyway, but Denmark has the EU’s largest oil output. The US, the UK and several other countries agreed at the Cop26 conference to stop funding overseas fossil fuel projects.
During the period of strong shale oil expansion, from 2008 to 2019 (with a couple of hiccups), Opec and then Opec+ became aware of the danger that high oil prices would bring a wave of competing supply. Now that is temporarily suspended because shareholders, tired of a decade of poor returns, are demanding cash generation rather than growth.
This restraint will not last if high prices continue. But, electoral commitments and the strength of the Democratic progressive wing mean the current US administration cannot pursue an “all-of-the-above” energy policy and encourage domestic oil, as former president Barack Obama could just a decade ago.
Output will concentrate in the lower-cost incumbent producers where government policy does not restrict hydrocarbon extraction: the core Middle East and North Africa, some Russian and other former Soviet fields, and parts of Latin America.
By 2050, the International Energy Agency projects that Opec’s market share will rise to 52 per cent, from 34 per cent currently, albeit of a much smaller consumption pie.
The issue is even more acute than this statistic shows because the key issue is not production bulk, but production growth – the ability to flood the market and drive down prices.
Opec has always been restrained by the concern of competition: other oil producers on one hand, conservation and alternative energy on the other. Now, the supply side of that competition is much weaker: Russia and several other important producers have been drawn into the Opec+ group, while several Opec countries are not able to boost output because of field maturity, underinvestment or political problems.
On the demand side, governments are already committed to fuel efficiency and electric-vehicle adoption. Mr Biden’s “Build Back Better” bill contains refundable tax credits up to $12,500 per battery car, the infrastructure bill has $7.5 billion for charging stations and car makers have been set a target of 50 per cent electric sales by 2030. The UK is to ban sales of new petrol and diesel cars from 2030. Higher oil prices will speed up adoption but the direction is set.
Western countries are going to keep encountering volatility and price shocks, at least until their oil use shrinks enough that it no longer matters much to consumers or the economy. Strategic reserves, co-ordination, efficiency and shale oil had together made European and American oil consumers complacent about energy security. Now, they may have to relearn the painful lessons about diversity and competition that the 1970s oil crises taught.
Robin Mills is the chief executive of Qamar Energy and the author of The Myth of the Oil Crisis