Oil is not Well
STICKY SITUATION: In this 2009 file photo, Iraqi workers operate a valve at an oil refinery in Zubair, Iraq. For now, low oil prices are a boon to oil-importing nations and a time for fiscal tightening for oil exporting countries
It is one of the most significant events of 2014. It has influenced geo-politics and impacted the economic scenario planning of every country. It is the sharp and dramatic decline in oil prices. From $115 a barrel in June, the price of oil has plummeted by nearly 50 per cent to around $60 per barrel at the time of writing.
Who are the gainers and losers? The clear gainers are countries like China, India, Germany and Japan that consume collectively much more than they produce. The obvious losers are Russia, Venezuela and Iran. The western media is regaling in schadenfreude because these three countries are not exactly friendly with the US and its allies.
The US, as a nation, is still a net importer of oil. Therefore, it will benefit. However, it is a mixed blessing as oil producing states in the US like Texas, Louisiana, Alaska, North Dakota and Oklahoma are already feeling the pinch. These states together will lose at least 200,000 jobs directly and twice that number or more, indirectly. The economics of the shale gas producers are being hit with a double-whammy of environmental protests and low oil prices. But the consumers at the gas station are cheering. Ironical, is it not, that the increase in output of shale gas is a one the reasons for the fall in global oil prices? And yet low oil prices are threatening to unravel new shale and renewable energy programmes.
Russia is in deep trouble. The former finance minister Aleksei Kudrin has admitted that the country is in the throes of “a full-blown economic crisis”. The ruble was in free fall until Russia pumped $90 billion from its reserves to keep its currency from sinking. It raised the interest rates from 10.5 per cent to 17 per cent. Advisers of president Vladimir Putin are whispering to him at every opportunity that it is not the best of times for Russia to moon the western giants.
Iran is losing $1 billion a month, creating a crater in its budget. It must pause to ponder whether moderating its nuclear programme is a pragmatic option and whether the time has come to make up and sup with the satan. After patching up with Cuba, president Obama seems to be inclined to bury the hatchet with Iran as long as it is serious about not building the bomb. Iran has always denied making the bomb, so it will not lose face either.
The joker in the pack is, of course, Venezuela. At $115 a barrel of oil, the rulers of Caracas were raking in 95 per cent of the exports from the dark liquid. It will be in deep turmoil as most of its social programmes — and foreign-assistance generosity — was essentially financed by high-priced oil revenues. That has now dried up.
Saudi Arabia is adamant in retaining its market share. It is pumping oil with abandon. In the process, it is hurting the economies of West Asia including its own. The unrepentant Saudi energy minister, Ali al-Naimi indicated a fundamental rethinking by Opec, saying that it needed to focus on keeping its market share rather than trying to raise prices by slashing production. “We have entered a scary time for the oil market,” he said.
Scary indeed! Just imagine, your largest customer, which fought a series of wars to protect its control over oil assets, has suddenly begun to produce what it needs or nearly so. By the way, Saudi Arabia will have a budget deficit of $39 billion.
Well, that is the supply story. The demand story is really the twist in the tale. Up until recently, electric cars like Tesla and its variants and hybrids in BMW, Audi, Toyota, GM and others were threatening to change the game by reducing the automobile industry’s dependence on hydrocarbons. Now a disruptive innovation is rearing its green and beautiful head. Toyota has announced a new series of cars called ‘The Mirai’, which in Japanese means, the future. It is powered by hydrogen fuel cells.
It is not just Toyota. Daimler, Honda, Hyundai, BMW and Audi have all announced hydrogen-fuel cell cars. This really means that the ecology and infrastructure of hydrogen fuel cells will come up rapidly. These cars have nearly zero emission and require no hydrocarbons to run. The real barrier to the adoption of these vehicles is the higher capital cost of the cars and not the availability of the fuel. As scale comes into play and the technology undergoes improvements, this hurdle of high initial cost will go.
If electrically operated vehicles, hybrids and hydrogen fuel cells expand their market shares, then the demand for oil will continue to decline. Going forward, we will see a steady increase in supplies of oil coupled with a decline in the growth rate of consumption, which is not a great position to be in for the oil industry.
The three great beneficiaries of the low oil prices are China, Japan and India. However, the low prices of crude are unlikely to last forever. For now, low oil prices are a boon to oil-importing nations and a time for fiscal tightening for oil exporting countries. But over a longer horizon, it seems that oil demand may moderate. Our planet will seek and find greener sources of energy that are renewable. As this swing takes place slowly but surely, there will be a shift and re-arrangement in wealth and in geo-political influences. The oligopoly of Opec will be under severe stress. Oil prices will rise in 2015 but I am tempted to mimic the catchphrase of the Bollywood movie 3 Idiots — ‘oil’ is not well.
(The writer is managing director of Deloitte Consulting, India. These are his personal views)