Major changes in oil production have transformed the US from a major importer to a major producer and sometime exporter of oil. The market power of OPEC and its non-member collaborators has been weakened (Libya and Nigeria have been exempted from current quotas). In addition to new sources of oil production, we are now hearing increasingly about limits to oil demand and when the peak oil DEMAND will be reached (Bloomberg). Increased production and trade in natural gas and growth in renewables decrease the demand for oil. The timing of peak oil demand will depend on improvements in batteries that power electric cars (Covert et al). Although batteries continue to limit the range of electric cars, auto producers, such as Volvo have recently made major commitments to introduce electric models. Volvo will phase out gas cars and go all electric or hybrid by 2019 (Wall Street Journal 2017a). India has announced that the nation will go all electric for new car sales by 2030(CNN). The result of fast growth in oil supply and slower growth in demand has been persistently low oil prices since December 2014.
US OIL PRODUCTION AND EXPORTS
Recent growth in US oil production has been described as revolutionary (see the chart below). US oil production reached its maximum in 1970 at 9.6 million barrels per day (www.eia.gov). It declined steadily for the next 38 years to 5.0 million barrels per day (mbd) in 2008. Since then there has been a major increase in production to 9.4 mbd in 2015 and production remained at 9.3 mbd in June 2017. The decline in production that took 38 years was approximately offset in 7 years. The US has become an oil exporter after legalizing exports in 2015, for the first time in 40 years. China has become a market for US crude, and US exports to China in the first seven months of 2017 were ten times what they were in 2016 (Wall Street Journal 2017b). The increase in US exports partly offset the decline in exports by the major OPEC members in 2017.
Natural gas is an important substitute for oil, but its availability has been traditionally limited by the necessity to transport it by pipeline. Total world supply of natural gas has also increased, and the ability to transport it by ships by converting gas into LNG has made it available to locations not served by pipelines. Adding a waterborne transport mode has integrated the world gas market and made it more competitive. Trade was once dominated by long-term contracts, but newer agreements are more flexible, and a spot market for LNG is emerging. The US producer, Cheniere, has already shipped LNG to China from its Sabine Pass terminal via the expanded Panama Canal. Trade by water requires special export and import terminals and tankers with special equipment. Cheniere has the only currently operating export terminal in the US, but 4 others are under production, and 13 more have requested licenses from the Federal Energy Regulatory Commission. The US is expected to become the world’s third leading exporter of natural gas after Qatar and Russia (Reuters). The largest current market is in Asia, and the leading exporters of LNG to Asia are Qatar and Australia. New import terminals for LNG in Poland and Lithuania have the potential to increase competition in Europe, and at the very least, put a lid on the price of natural gas charged by Russia. The Lithuanian terminal at Klaipeda, on the Baltic Sea, has been operating since 2014. Poland’s import terminal is at the Baltic port of Swinoujscie, and it has received LNG since 2016.
New supplies and transport opportunities have benefitted the US, but they have harmed traditional producers, including Russia and Saudi Arabia. Russia has been harmed by low prices for oil and natural gas and new supplies of LNG that reduced their monopoly power in Eastern Europe. The price declines since 2014 were large, but they were even larger in the past. The price of oil fell from $100 per barrel in June 2014 to $50 in December 2014. There was a greater price decline (adjusted for inflation) earlier from $96.54 in 1980 to $29.84 in 1986. The real price remained below $40 from 1986 to 2004. This large and persistent drop coincided with the disintegration of the USSR. An important current question is whether the low prices will be brief or long lasting? “Lower for longer has become the new mantra in the industry” said Daniel Yergin. “People are gearing themselves to a new price level and $50 to $60 seems acceptable to most”. (Wall Street Journal 2017d). In an earlier piece in 2016, we argued that the price of oil might never get back above $100 (inflation adjusted) per barrel (Strazds and Grennes).
The availability of new supplies of LNG has reduced the leverage that Russia has over Eastern European customers. Russia’s traditional market power derived from the need to transport natural gas by regional pipelines. Poland and Lithuania now have operating LNG import terminals on the Baltic Sea, and they have imported LNG from the United States, Norway (Statoil), and Qatar. Qatar, currently the world’s largest LNG exporter, has concluded a new agreement with 3 major global oil companies ExxonMobil, Royal Dutch Shell, and Total) to expand its production and trade. Qatar has agreed to increase its production and exports of LNG by 30%. There continues to be controversy over the location of new gas pipelines bringing supplies from Russia, including the Nord Stream 2 that would run from Russia to Germany under the Baltic Sea and will make Germany more dependent on Russian gas. However, in the case of Eastern European customers, even if they continue to buy natural gas from Russia, the availability of substitute sources from other regions improves their bargaining position.
Both Saudi Arabia and Russia are adversely affected by the oil price decline. However, there are important differences between the countries. Saudi Arabia has accumulated a much larger stock of oil-related wealth than Russia. The combined size of the Reserve Fund and the National Wealth Fund of Russia is only USD90 billion or 6.2% OF GDP (Ministry of Finance of the Russian Federation) as of July 2017. Saudi Arabia’s government deposits at the Saudi Monetary Authority, although they have fallen by $250 in the last three years, were still at 39.4% of GDP at the end of 2016 (IMF). The demographics in the two countries are also quite different. In Saudi Arabia, more 45% of the population is below the age of 25. Russia has an older population, and the corresponding number is just above 26% (CIA). Thus, while Saudi Arabia has a larger reserve to allow for a gradual diversification of its economy away from oil, the demographic pressure is likely to work in the opposite direction.
The sharp drop in the real oil price from 1980-1986 induced a large drop in Saudi income. Saudi real per capita income fell from $54,500 in 1980 to $31,000 in 1986. The negative economic shock was persistent, and the real price of oil remained below $40 for another 18 years. Moreover, OPEC countries lost significant market share as a result of trying to prop up the price by limiting production.
Saudi Arabia has been badly harmed by the current oil glut and they are aware of the earlier low price period and the severe economic effects on them. The Saudi’s initial response to the present glut was to increase production to preserve their market share. In 2016, Aramco, produced 10.5 million barrels per day, an all-time record output (Wall Street Journal 2017c). Since then, Saudi Arabia has pulled back from this strategy, arguably to put a floor on the price at a level that can safeguard new investment in oil production. It has joined major OPEC producers in reducing output in hopes of stabilizing the price. So far in 2017, Saudi production has fallen to 10.0 million barrels per day. However, reductions in output from OPEC have been largely offset by increases from the US and elsewhere.
JONES ACT AND US TRADE
The US can gain as a producer and exporter of natural gas, but the extent of the gain depends on its own policies. The US Jones Act requires the use of American ships to transport goods from one domestic port to another. Since new American-built ships cost five times as much as foreign-built ships, there are no Jones Act-compliant tankers to service domestic trade. It is odd that the benefits from the new LNG trade go to faraway destinations, such as Poland, Lithuania, and China, but not to Americans who do not live near pipelines. After banning exports of crude oil in the 1970s, Congress finally allowed exports of crude in 2015. However, protectionist forces are strong in the Congress, and there is a bill in the House (Garamendi bill) that would require the use of American-flag ships to export some minimum percentage of LNG and crude oil.
How much “lower and longer” is a crucial question for the world’s oil and gas industries and their users. Historically, periods of low prices have been followed by periods of higher prices, but will the recovery of prices take 3 years or 20 years? Or is it possible that recent developments in production and trade in oil and natural gas and their demand have been truly transformative? Will the real price of oil and gas remain permanently low? Only time will tell, but the outcome will have very different effects on the US, Russia, and Saudi Arabia.
Bloomberg. 2017. “Remember Peak Oil? Demand May Top Out Before Supply Does”. July 11. See here.
Covert, Thomas, Michael Greenstone, and Christopher Knittel. 2016. “Will We Ever Stop Using Fossil Fuels?” Journal of Economic Perspectives 30(1): 117-138.
CIA. The World Factbook. See here.
CNN. 2017. India to sell only electric cars by 2030. June 3. See here..
Economist. 2017. “Put That in Your Pipe: A Proposed Russian-German Gas Deal Smells Funny to America”. June 24.
Energy Information Agency. See here.
Grennes, Thomas. 2017 “Revolutionary Changes in Production and Trade: USA vs. Russia and Saudi Arabia: July 2017.
Grennes, Thomas, and Andris Strazds. 2015, “Consequences of the World Oil Glut”. EconoMonitor, April 2.
Grennes, Thomas , and Andris Strazds. 2014. “Increasing Energy Security from a Transatlantic Trade Pact. EconoMonitor. May 27.”
Reuters. “Exclusive: Energy Giants Court Qatar for Gas Expansion Role Despite Crisis”. Reuters, 7-5-17.
Reuters 2017. See here..
Reuters. 2017. “Energy Giants Court Qatar for Gas Expansion Role Despite Crisis”. July 5.
Strazds, Andris and Thomas Grennes. 2016. “Will We Ever See Oil Back Above 100 USD per Barrel?” EconoMonitor. February 10. See here.
Wall Street Journal. 2017a. “Volvo Announces Phase Out of Conventional Car Engines”. See here.
Wall Street Journal. 2017b. “China Sucks UP US Oil Exports”. July 7.
Wall Street Journal. 2017c. “Aramco Output Hits Record”. July 7.
Wall Street Journal. 2017d. “Oil Companies Adapt to a Low-Price World. June 20.