As the oil price this week stared over the precipice of another downward spiral below $US40 a barrel, energy futurist Jeremy Leggett posed a loaded question: “Might the fossil fuel industries implode faster than the clean energy industries can grow to replace them?”
Continued low prices, falling company profits and cancelled exploration spending can paint a worrying picture.
But if there is a lesson in what has been happening with oil it is that innovation and free market ingenuity still beat attempts at co-ordinated state control. In short, the oil market recovery that pushed the price of oil past $US50 a barrel has stalled. Wishful thinking of earlier this year that OPEC could regroup with Russia to bolster cartel power against emerging producers in the US has proved to be just that. In this oil war, like all wars, self-interest has won through.
Many argue the retreat of prices back below $US40 a barrel has serious implications for long-term supplies because trillions have been cut from exploration spending worldwide. Lower prices will make more difficult the planned transition to lower-emissions power generation in Australia and beyond.
But geopolitical rivalries appear not to be concerned with these realities. With the world awash with oil, Saudi Arabia is still refusing to cut production. In addition, it is undercutting Iran on price in a bid to limit its mortal enemy from getting a foothold in Asian markets after the lifting of nuclear program sanctions by the US. While Russia had talked of greater co-operation with OPEC, the Kremlin was changing tax laws to encourage a boost in its own domestic oil production. Meanwhile, instead of rolling over as the Saudis hoped they would, efficient US shale producer
s have become even more efficient.
The collapse in shale production that many believed the Saudis were hoping to engineer when they refused to cut production and crashed the oil price from more than $US100 a barrel in late 2014 has not happened.
Instead, shale industry leaders in the US are saying they can survive with the price of oil at $US40 a barrel.
Put simply, and to the dismay of oil-dependent regimes — from the Middle East to Russia, South America and Africa — the shale oil and gas miracle continues to deliver for the US.
This reality was captured in an article in Britain’s Telegraph newspaper this week that explained why OPEC’s worst fears were coming true. North America’s hydraulic frackers were cutting costs so fast that most could produce at prices far below levels needed to fund the Saudi welfare state and its military machine, or to cover OPEC nations’ budget deficits.
Technological improvements had allowed wells to be kept in production longer and to deliver a much greater percentage of contained reserves. Rather than being forced out, those working on the most productive shale formations were starting to drill again.
Scott Sheffield, the outgoing chief executive of Pioneer Natural Resources, told theTelegraph the Permian shale formation was as bountiful as Saudi Arabia’s giant Ghawar field. He said production there could expand from two million to five million barrels a day, even if the price of oil never rose above $US55.
On the cost front, Pioneer’s production expenditure had been cut by 26 per cent in the past 12 months. The company was now so efficient it was adding five new rigs, and improvements in drilling technology meant each rig could drill up to five wells at a time.
In the short term, at least, this is the disaster scenario for OPEC. Many market analysts had expected a day of reckoning for US shale players when hedging contracts expired in the first half of this year.
In reality only a few heavily indebted producers went bankrupt and assets were snapped up by private equity groups at fire-sale prices. This is creative destruction at
work.
And what it means is that the geopolitical ructions of the collapsed oil price on already unstable economies and regimes have some way yet to run. The social and security implications are most pronounced for countries such as Venezuela and Nigeria.
But, ultimately, continued low prices could pose an existential threat to regimes in Saudi Arabia and Russia that have built a social contract based on prices above $US100 a barrel.
For Australia, the low price of oil has rendered unprofitable — in the short term, at least — the more than $30 billion spent on liquefied natural gas export terminals in Queensland.
When the three Queensland LNG projects took their final investment decisions from October 2010 to January 2012, the oil price averaged about $US108 a barrel.
This week analysts declared it had re-entered a bear market at below $US40.
In turn, low prices have pulled investment from developing new reserves while existing capacity has been directed towards export markets.
After a 12-month review of the east coast gas market, Australian Competition & Consumer Commission chairman Rod Sims said while it was clear there were sufficient east coast reserves to meet demand, it was not at all clear whether these reserves would be developed in a timely fashion.
The ACCC said there were three key factors feeding into the uncertainty about future gas supply on the east coast:
• Gas flows to the LNG projects, which were removing gas from the domestic market.
• The low oil price, which was resulting in declining investment in gas exploration and lower production forecasts for domestic and LNG projects.
• Moratoriums and regulatory restrictions that were affecting onshore gas exploration and development in NSW, Victoria, Tasmania and potentially the Northern Territory.
The issue of gas price and supply has been brought to a head by spikes in spot
electricity supplies in South Australia where high-priced gas is being used to balance the intermittent power supplies from renewables. Ironically, as world prices have fallen, retail prices for domestic consumers have risen, making more difficult the hoped-for transition to lower emissions power generation.
A series of inquiries have already examined the state of affairs in gas and a Council of Australian Governments meeting of energy ministers has been called to look for solutions.
Ultimately, they are likely to zero in on boosting transparency and competition in how gas is transported to users via the interstate pipeline network.
There is also likely to be further confrontation over developing unconventional gas supplies in NSW, Victoria and the Northern Territory.
If debate is conducted against a backdrop of continued low world prices the expected transition away from coal will be made that much more difficult. It underscores the question raised by Leggett.
What does happen if fossil fuel industries implode faster than the clean energy industries can grow to replace them? And who would rightly take responsibility for that?
STX Price at posting:
12.0¢ Sentiment: Buy Disclosure: Held
(20min delay)