The reason oil could drop as low as $20 per barrel

Updated 20 December 2014

The reason oil could drop as low as $20 per barrel

LONDON: How low can it go — and how long will it last? The 50 percent slump in oil prices raises both those questions and while nobody can confidently answer the first question (I will try to in a moment), the second is pretty easy.
Low oil prices will last long enough for one of two events to happen. The first possibility, the one most traders and analysts seem to expect, is that Saudi Arabia will strengthen OPEC's power once it achieves the true geopolitical or economic objectives that spurred it to trigger the slump. The second possibility, one I wrote about two weeks ago, is that the global oil market will move toward normal competitive conditions in which prices are set by the marginal production costs, rather than OPEC's domination. This may seem like a far-fetched scenario, but it is more or less how the oil market worked for two decades from 1986 to 2004.
Whichever outcome finally puts a floor under prices, we can be confident that the process will take a long time to unfold. It is inconceivable that just a few months of falling prices will be enough time for Gulf exporters to reverse the growth of shale oil production in the United States. It is equally inconceivable that the oil market could quickly transition from OPEC domination to a normal competitive one. The many bullish oil investors who still expect prices to rebound quickly to their pre-slump trading range are likely to be disappointed. The best that oil bulls can hope for is that a new, and substantially lower, trading range may be established as the multi-year battles over Middle East dominance and oil-market share play out.
The key question is whether the present price of around $55 will prove closer to the floor or the ceiling of this new range. The history of inflation-adjusted oil prices, deflated by the US Consumer Price Index, offers some intriguing hints. The 40 years since OPEC first flexed its muscles in 1974 can be divided into three distinct periods. From 1974 to 1985, West Texas Intermediate, the US benchmark, fluctuated between $48 and $120 in today's money. From 1986 to 2004, the price ranged from $21 to $48 (apart from two brief aberrations during the 1998 Russian crisis and the 1991 war in Iraq). And from 2005 until this year, oil has again traded in its 1974 to 1985 range of roughly $50 to $120, apart from two very brief spikes in the 2008-09 financial crisis.
What makes these three periods significant is that the trading range of the past 10 years was very similar to the 1974-85 first decade of OPEC domination, but the 19 years from 1986 to 2004 represented a totally different regime. It seems plausible that the difference between these two regimes can be explained by the breakdown of OPEC power in 1985 and the shift from monopolistic to competitive pricing for the next 20 years, followed by the restoration of monopoly pricing in 2005 as OPEC took advantage of surging Chinese demand.
In view of this history, the demarcation line between the monopolistic and competitive regimes at a little below $50 a barrel seems a reasonable estimate of where one boundary of the new long-term trading range might end up. But will $50 be a floor or a ceiling for the oil price in the years ahead?
There are several reasons to expect a new trading range as low as $20 to $50, as in the period from 1986 to 2004. Technological and environmental pressures are reducing long-term oil demand and threatening to turn much of the high-cost oil outside the Middle East into a "stranded asset" similar to the earth's vast unwanted coal reserves. Additional pressures for low oil prices in the long term include the possible lifting of sanctions on Iran and Russia and the ending of civil wars in Iraq and Libya, which between them would release additional oil reserves to the world markets.
The US shale revolution is perhaps the strongest argument for a return to competitive pricing instead of the OPEC-dominated monopoly regimes of 1974-85 and 2005-14. Although shale oil is relatively costly, production can be turned on and off much more easily — and cheaply — than from conventional oilfields. This means that shale prospectors should now be the "swing producers" in global oil markets. In a truly competitive market,low-cost producers would always be pumping at maximum output, while shale shuts off when demand is weak and ramps up when demand is strong. This competitive logic suggests that marginal costs of US shale oil, generally estimated at $40 to $50, should in the future be a ceiling for global oil prices, not a floor.
On the other hand, there are also good arguments for OPEC-monopoly pricing of $50 to $120 to be re-established once markets test the bottom of this range. OPEC members have a strong interest in preventing a return to competitive pricing and could learn to function again as an effective organization. Although price-fixing becomes more difficult as US producers increase market share, OPEC could try to impose pricing "discipline" if it can knock out many US shale producers next year. The macro-economic impact of low oil prices on global growth could help this effort by boosting economic activity and energy demand.
So which of these arguments will prove right: The bearish case for a $20 to $50 trading-range based on competitive market pricing? Or the bullish one for $50 to $120 based on resumed OPEC dominance?
Ask me again once the price of oil has fallen to $50 — and stayed there for a year or so.

— Anatole Kaletsky is an award-winning journalist and financial economist. The opinions expressed here are those of the author.


Middle East chief executives share global gloom on economic prospects

Updated 21 January 2020

Middle East chief executives share global gloom on economic prospects

  • Only China and India among the major economic blocs were less pessimistic on average
  • Trade wars, geopolitical tensions and climate change threats were the factors weighing most heavily on executive minds

DAVOS: Global business chiefs are more pessimistic about prospects for the world economy than for many years, and senior executives in the Middle East are among the most gloomy, according to the annual survey of chief executive officers’ opinion released at the World Economic Forum annual meeting in Davos.

The poll — by consulting firm PwC — showed that a record number of CEOs were pessimistic about the international economy, with an average of 53 percent predicting a decline in the rate of growth in 2020.

While bosses in North America and Europe were particularly downbeat about prospects, with 63 percent and 59 percent saying they thought things would get worse this year, CEOs in the Middle East were also more gloomy than average, with 57 percent predicting lower growth this year.

Only China and India among the major economic blocs were less pessimistic on average, but there was a sharp decline in the number of Chinese executives who wanted to do business with the US — just 11 percent identified the US as their most attractive market, compared with 59 percent two years ago.

Trade wars, geopolitical tensions and climate change threats were the factors weighing most heavily on executive minds — apart from the standard complaints about over-regulation by governments.

Unveiling the 2020 results, PwC chairman Bob Moritz said: “Given the lingering uncertainty over trade tensions, geopolitical issues and the lack of agreement on how to deal with climate change, the drop in confidence in economic growth is not surprising – even if the scale of the change in mood is.”

Last year, there was a record number of CEOs who said they were optimistic about global economic growth, and only 29 percent said they were pessimistic.

“These challenges facing the global economy are not new. However, the scale of them and the speed at which some of them are escalating is new, the key issue for leaders gathering in Davos is: How are we going to come together to tackle them,” Moritz added.

The poll of 1,600 CEOs in 83 countries was taken toward the end of last year, before tensions in the Middle East escalated in the Arabian Gulf, but before the tentative “phase one” agreements on world trade between the US and China.

The poll was also taken before the Australian wildfires further highlighted fears of climate change — a major focus of the WEF meeting.

The poll also found CEOs less confident than ever in their own companies’ prospects, with only 27 percent of CEOs saying they are “very confident” in their own organization’s growth over the next 12 months – the lowest level PwC has recorded since 2009 and down from 35 percent last year.