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OPEC DECISION NOT TO REDUCE OIL SUPPLY IS STRATEGIC By: Esan Mascot Ogunjemiyo

In the third edition of NAPIMS NEWS, I explained the factors that kept oil price high and why Brent price below US$80 per barrel (resulting from surge in oil production from tight sand and shale in North America) was not sustainable. Some of the reasons adduced in the article are.

1. High depletion rate of shale reservoirs.

2. Near monopoly of oil as transportation fuel.

3. Demand Growth in emerging economies of Asia and Africa.

4. High production cost per barrel (over US$70 for most tight sand and shale oil fields).

5. OPEC influence. OPEC took a different twist, at its meeting of November 27, 2014, taking the oil market by surprise with its decision not to reduce production. This decision by OPEC to maintain its current level of supply to the global oil market (put at 30 million barrel per day) is strategic, even though the decision may have negative short term impact on the economy of many of its member countries. Part of the argument that might have favoured OPEC decision is as follows:

Premise for Decision

1. The tactical and defensive decision for OPEC would have been to reduce its output as a means of creating supply short fall thereby, boosting prices. But the impact of such production curtailment would have been short lived, given the fact that the current oversupply driven by technology and innovations resulted from the incentives created by the rising prices of oil, which have made unconventional resources (particularly shale oil) and marginal reserves profitable. Production cut may therefore imply more market share for shale oil and other unconventional producers.

2. High oil prices witnessed since 2005 have also created opportunity for other industries to capture some of the demand for transportation by producing more efficient engines, vehicles, ships and aircraft, and by supplying alternative liquid fuels such as biodiesel. Efficiency of the internal-combustion engine has improved substantially as a result of rapid advances in engine and vehicle design. Petrol and diesel engines manufacturers continue to offer more millage per litre of fuel.

Materials used to make cars are getting lighter and stronger. The growing popularity of electric and hybrid cars, as well as vehicles powered by natural gas and hydrogen fuel cells are also reducing the market share of oil in the global energy market.

3. Stricter environmental policies that are reducing the dependent on fossil oil in Europe and America through tougher fuel-efficiency standards on vehicles are also being adopted in the developing economies of Asia particularly China and India. China recently introduced its own set of fueleconomy measures that could slow Asia demand for oil.

Implications of OPEC Decision and low oil price

OPEC’s cautious decision is simply an indication that the current oil prices still stand at a level that is acceptable to member countries However, some American reports viewed OPEC decision to maintain production at this time of sliding price of crude oil, “a declaration of war against North American tight sand and shale oil producers”.

In my opinion Shale oil and other unconventional producers would adapt to the new realities of low oil price regime. They will adopt strategy that will sustain production for longer periods. It is unlikely that low oil prices decimate shale oil business and the industries which it has created.

In general, low oil price is good news for the world economy.

Import dependent countries of Europe and Asia will rip enormous benefit, as the effect of the falling oil price filters through the economy, impacting positively on the cost of goods and services thus, boosting the economy as a whole.

On the other hand, economies of OPEC members and countries like Russia who are heavily dependent on oil export to fund their national budgets are susceptible to fluctuations in global oil prices. Saudi Arabia with it huge cash reserves of over US$ 800 billion and relatively low budget benchmark can withstand a period of low oil prices for some time, while other oil exporters will struggle to finance their bloated social welfare. Considering the current trend, Nigeria’s revised
2015 budget benchmark crude oil price of US$73 appears too optimistic. Today, the reality at hand is the free fall of oil price below US$50 if lower oil prices linger, companies like ExxonMobil, Shell and BP would revise their internal planning assumptions, making project sanctioning harder.

Investment in exploration may also be less attractive.

Conclusion

No doubt, crude oil would remain a useful natural resource to mankind. But its dominance in the global economy and energy mix, particularly as transport fuel, which is gradually being challenge by technology and innovations, will wane with time. The cheaper oil becomes the longer it would take to diminish its relevance.

It is therefore, time for OPEC members and other countries like Russia who have over time tied their fiscal expenditure to revenue derived from crude oil export, to formulate policies and implement strategies that will create value chains which will optimise crude oil utilisation and create demand within their territories rather than challenging the ingenuity and creative instinct of man through artificial scarcity.

 

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