US shale oil stares into abyss with Opec ready push it over

Andrew Critchlow in The Telegraph


After hanging on for almost a year, the US shale oil industry is on the brink of complete capitulation. The reason for its impending downfall is simple: the lowest cost producer always wins. In this instance the most profitable producers are Saudi Arabia and its close Gulf Arab allies, who effectively control the Organisation of the Petroleum Exporting Countries (Opec).


To their credit, shale drillers and operators in Texas and North Dakota have hung on for far longer than anyone expected after Opec launched its pre-emptive oil price war last November. However, a year of oil prices trading at an average of around $50 per barrel is finally succeeding in reversing the dramatic increases in US production that had been so troubling the Gulf’s oil-rich sheikhs.


Total US output has fallen by almost 600,000 barrels per day (bpd) since the end of the first quarter, with the biggest declines occurring recently as operators begin to crack under the financial pressure caused by Opec’s squeeze on prices. By next year, the US government expects output to decline to an average of 8.6m bpd, down from an average of 9.3m bpd in 2015.


According to Mark Papa, the former head of US shale oil specialist operator EOG Resources, this is just the beginning of the downturn in North America. Speaking at the annual Oil and Money conference in London this week, Mr Papa said: “We are about to see a pretty dramatic decline in US production growth.”


The insurmountable problem the US shale oil industry faces is that it is too highly dependent on debt and too reliant on crude trading above $60 per barrel to remain profitable. Break-even prices in America’s most productive areas, such as the Eagle Ford and Bakken, are thought to range from $54 to almost $70 a barrel, which currently means producers are operating at a loss, living in hope that Opec finally relents and cuts production.




In these circumstances the only thing keeping many US drillers afloat is debt, which up until now has been cheap and plentiful.

According to the data provider Factset, the amount of debt held by US oil and gas producers has ballooned to almost $170bn (£111bn) this year, compared with $81bn five years ago. But the cost of servicing that debt has also increased exponentially after a number of operators saw their ratings reduced to junk.

Opec now only has to maintain its fragile cohesion and push a little harder for the entire shale oil industry in the US to fold.

However, the group of 12 mainly Middle Eastern oil producers is itself feeling the pain of lower oil prices. Its wealthiest members, such as Saudi Arabia, the United Arab Emirates and Kuwait, are having to fall back on their foreign currency reserves for the first time in almost 20 years to make up for the shortfall in revenues.

Poorer member countries such as Venezuela, Algeria and Nigeria are now at economic breaking point. Without vast sovereign wealth funds and an abundance of cheap oil, they are close to buckling and are demanding that Opec meets to revise its current strategy.

Although Opec’s secretary general has called for a meeting of oil experts in Vienna later this month, it is extremely unlikely that ministers from the group will gather before their next scheduled date in December. Meanwhile, Saudi Arabia has continued to pump at record rates above 10.5m bpd, a strategy which is making a mockery of Opec’s overall production ceiling of 30.5m bpd.

And then there is Iran and Iraq. Combined, these close political allies in the Middle East pose the biggest challenge to Saudi Arabia’s dominance of Opec. However, both countries desperately need higher oil prices to help shore up their battered economies.

Baghdad has compensated for falling oil prices by pumping more crude. The second largest producer in Opec is now pumping around 4m bpd of crude to replenish its dwindling foreign currency reserves, which have fallen by around 20pc this year.

Iran is also champing at the bit to increase production – with the end in sight for its economic isolation from the rest of the world. According to the Iranian government, the country could increase oil production by around 500,000 barrels per day within a few months of economic sanctions being fully lifted. The Islamic republic is already laying the foundations for a return of international oil companies, which could help to boost output.

Top oil official Seyed Mehdi Hosseini told a room packed with Western executives at the Oil and Money conference that Tehran was ready to offer 50 new projects to international investors. Any significant increase in Iranian oil supply would add to the current oversupply in markets, pushing prices even lower.

Currency wars in emerging markets hammer global stocks

 Ben Chu in The Independent

Developing world devaluations have sent global stock markets into a funk and stoked fears of an intensifying global currency war.

In response to China’s surprise devaluation of the yuan last week, several emerging market economies have slashed the value of their own currencies to retain their competitiveness.

Kazakhstan’s tenge lost 24 per cent of its value against the dollar after the country’s central bank announced that it would allow the currency to float freely. Meanwhile, South Africa’s rand slid to its weakest level against the dollar in 14 years and Malaysia’s ringgit fell to its lowest level against the greenback in 17 years. Turkey’s lira and the Russian rouble also dropped.

This followed the decision by Vietnam on Wednesday to cut the value of the dong against the dollar by 1 per cent, the country’s third devaluation of the year. Since Beijing’s yuan devaluation last week, an index of 20 developing-nation exchange rates has been falling fast.

The ructions depressed the FTSE100, pushing the index down into technical “correction” territory, more than 10 per cent below its April peak. Year-to-date, the benchmark index of UK-listed shares, is down 2.9 per cent. The S&P 500 also quickly fell 1.2 per cent after trading opened in America, wiping out all of the US index’s gains made this year.

Last week, the People’s Bank of China caught markets napping by allowing the yuan to fall in value against the dollar by 4 per cent in two days. The perception that the world’s single biggest customer for raw materials is in economic difficulties has stoked fear over the prospects of big commodity producing economies like Kazakhstan, Russia, Brazil, South Africa and Malaysia. The slumping global oil price has also hammered investor confidence in the prospects of the big energy exporters.


“The appearance of China weakening its exchange rate to boost growth has added urgency for policymakers elsewhere to do what they can to grab more export revenue” said Koon Chow, of Union Bancaire Privée.

Many analysts expect further global devaluations if the US Federal Reserve, as expected, increases interest rates for the first time since the financial crisis later this year. “Emerging market currencies, in general, still have high devaluation risks” said analysts at CrossBorder Capital. Analysts predicted the likes of Egypt and Nigeria could be next to devalue their currencies.

Per Hammarlund, of Sweden’s SEB, said Kyrgyzstan, Turkmenistan and Tajikistan could allow their currencies to depreciate by between 10 and 20 per cent. “They simply don’t have much of a choice but to follow Russia and emerging markets more generally,” he said.

Capital has been flowing out of emerging markets at a rapid rate this year, as fears rise of a sharp slowdown in the former stars of the global economy. Over the past 13 months $1 trillion is estimated to have flowed out of the 19 largest emerging countries.
The International Monetary Fund expects global growth among emerging markets and developing economies to be just 4.2 per cent this year, the weakest output growth since 2009.

Nariman Behravesh, of IHS Global Insight, said emerging markets are arguably facing “the toughest environment since the Asia Crisis of the late 1990s” and predicted that they will drag on global growth into next year.

The end of Wahhabism? Saudi Arabia may go broke soon

Ambrose Evans Pritchard in The Telegraph

If the oil futures market is correct, Saudi Arabia will start running into trouble within two years. It will be in existential crisis by the end of the decade.

The contract price of US crude oil for delivery in December 2020 is currently $62.05, implying a drastic change in the economic landscape for the Middle East and the petro-rentier states.

The Saudis took a huge gamble last November when they stopped supporting prices and opted instead to flood the market and drive out rivals, boosting their own output to 10.6m barrels a day (b/d) into the teeth of the downturn.

Bank of America says OPEC is now "effectively dissolved". The cartel might as well shut down its offices in Vienna to save money.

If the aim was to choke the US shale industry, the Saudis have misjudged badly, just as they misjudged the growing shale threat at every stage for eight years. "It is becoming apparent that non-OPEC producers are not as responsive to low oil prices as had been thought, at least in the short-run," said the Saudi central bank in its latest stability report.

"The main impact has been to cut back on developmental drilling of new oil wells, rather than slowing the flow of oil from existing wells. This requires more patience," it said.

One Saudi expert was blunter. "The policy hasn't worked and it will never work," he said.

By causing the oil price to crash, the Saudis and their Gulf allies have certainly killed off prospects for a raft of high-cost ventures in the Russian Arctic, the Gulf of Mexico, the deep waters of the mid-Atlantic, and the Canadian tar sands.

Consultants Wood Mackenzie say the major oil and gas companies have shelved 46 large projects, deferring $200bn of investments.

The problem for the Saudis is that US shale frackers are not high-cost. They are mostly mid-cost, and as I reported from the CERAWeek energy forum in Houston, experts at IHS think shale companies may be able to shave those costs by 45pc this year - and not only by switching tactically to high-yielding wells.

Advanced pad drilling techniques allow frackers to launch five or ten wells in different directions from the same site. Smart drill-bits with computer chips can seek out cracks in the rock. New dissolvable plugs promise to save $300,000 a well. "We've driven down drilling costs by 50pc, and we can see another 30pc ahead," said John Hess, head of the Hess Corporation.

It was the same story from Scott Sheffield, head of Pioneer Natural Resources. "We have just drilled an 18,000 ft well in 16 days in the Permian Basin. Last year it took 30 days," he said.

The North American rig-count has dropped to 664 from 1,608 in October but output still rose to a 43-year high of 9.6m b/d June. It has only just begun to roll over. "The freight train of North American tight oil has kept on coming," said Rex Tillerson, head of Exxon Mobil.

He said the resilience of the sister industry of shale gas should be a cautionary warning to those reading too much into the rig-count. Gas prices have collapsed from $8 to $2.78 since 2009, and the number of gas rigs has dropped 1,200 to 209. Yet output has risen by 30pc over that period.

Until now, shale drillers have been cushioned by hedging contracts. The stress test will come over coming months as these expire. But even if scores of over-leveraged wild-catters go bankrupt as funding dries up, it will not do OPEC any good.

The wells will still be there. The technology and infrastructure will still there. Stronger companies will mop up on the cheap, taking over the operations. Once oil climbs back to $60 or even $55 - since the threshold keeps falling - they will crank up production almost instantly.

OPEC now faces a permanent headwind. Each rise in price will be capped by a surge in US output. The only constraint is the scale of US reserves that can be extracted at mid-cost, and these may be bigger than originally supposed, not to mention the parallel possibilities in Argentina and Australia, or the possibility for "clean fracking" in China as plasma pulse technology cuts water needs.

Mr Sheffield said the Permian Basin in Texas could alone produce 5-6m b/d in the long-term, more than Saudi Arabia's giant Ghawar field, the biggest in the world.

Saudi Arabia is effectively beached. It relies on oil for 90pc of its budget revenues. There is no other industry to speak of, a full fifty years after the oil bonanza began.

Citizens pay no tax on income, interest, or stock dividends. Subsidized petrol costs twelve cents a litre at the pump. Electricity is given away for 1.3 cents a kilowatt-hour. Spending on patronage exploded after the Arab Spring as the kingdom sought to smother dissent.

The International Monetary Fund estimates that the budget deficit will reach 20pc of GDP this year, or roughly $140bn. The 'fiscal break-even price' is $106.

Far from retrenching, King Salman is spraying money around, giving away $32bn in a coronation bonus for all workers and pensioners.

He has launched a costly war against the Houthis in Yemen and is engaged in a massive military build-up - entirely reliant on imported weapons - that will propel Saudi Arabia to fifth place in the world defence ranking.

The Saudi royal family is leading the Sunni cause against a resurgent Iran, battling for dominance in a bitter struggle between Sunni and Shia across the Middle East. "Right now, the Saudis have only one thing on their mind and that is the Iranians. They have a very serious problem. Iranian proxies are running Yemen, Syria, Iraq, and Lebanon," said Jim Woolsey, the former head of the US Central Intelligence Agency.

Money began to leak out of Saudi Arabia after the Arab Spring, with net capital outflows reaching 8pc of GDP annually even before the oil price crash. The country has since been burning through its foreign reserves at a vertiginous pace.

The reserves peaked at $737bn in August of 2014. They dropped to $672 in May. At current prices they are falling by at least $12bn a month.

Khalid Alsweilem, a former official at the Saudi central bank and now at Harvard University, said the fiscal deficit must be covered almost dollar for dollar by drawing down reserves.

The Saudi buffer is not particularly large given the country fixed exchange system. Kuwait, Qatar, and Abu Dhabi all have three times greater reserves per capita. "We are much more vulnerable. That is why we are the fourth rated sovereign in the Gulf at AA-. We cannot afford to lose our cushion over the next two years," he said.

Standard & Poor's lowered its outlook to "negative" in February. "We view Saudi Arabia's economy as undiversified and vulnerable to a steep and sustained decline in oil prices," it said.

Mr Alsweilem wrote in a Harvard report that Saudi Arabia would have an extra trillion of assets by now if it had adopted the Norwegian model of a sovereign wealth fund to recyle the money instead of treating it as a piggy bank for the finance ministry. The report has caused storm in Riyadh.

"We were lucky before because the oil price recovered in time. But we can't count on that again," he said.

OPEC have left matters too late, though perhaps there is little they could have done to combat the advances of American technology.

In hindsight, it was a strategic error to hold prices so high, for so long, allowing shale frackers - and the solar industry - to come of age. The genie cannot be put back in the bottle.

The Saudis are now trapped. Even if they could do a deal with Russia and orchestrate a cut in output to boost prices - far from clear - they might merely gain a few more years of high income at the cost of bringing forward more shale production later on.

Yet on the current course their reserves may be down to $200bn by the end of 2018. The markets will react long before this, seeing the writing on the wall. Capital flight will accelerate.

The government can slash investment spending for a while - as it did in the mid-1980s - but in the end it must face draconian austerity. It cannot afford to prop up Egypt and maintain an exorbitant political patronage machine across the Sunni world.

Social spending is the glue that holds together a medieval Wahhabi regime at a time of fermenting unrest among the Shia minority of the Eastern Province, pin-prick terrorist attacks from ISIS, and blowback from the invasion of Yemen.

Diplomatic spending is what underpins the Saudi sphere of influence caught in a Middle East version of Europe's Thirty Year War, and still reeling from the after-shocks of a crushed democratic revolt.

We may yet find that the US oil industry has greater staying power than the rickety political edifice behind OPEC.

Oil discovery near Gatwick airport 'significant'

By John Moylan

Industry correspondent, BBC News

• 3 hours ago 9 April 2015
 
• From the sectionBusiness

UK Oil & Gas believes its exploratory well at Horse Hill, Surrey, shows great promise

There could be up to 100 billion barrels of oil onshore beneath the South of England, says exploration firm UK Oil & Gas Investments (UKOG).

Last year, the firm drilled a well at Horse Hill, near Gatwick airport, and analysis of that well suggests the local area could hold 158 million barrels of oil per square mile.

But only a fraction of the 100 billion total would be recovered, UKOG admits.

The North Sea has produced about 45 billion barrels in 40 years.

"We think we've found a very significant discovery here, probably the largest [onshore in the UK] in the last 30 years, and we think it has national significance," Stephen Sanderson, UKOG's chief executive told the BBC.

UKOG says that the majority of the oil lies within the Upper Jurassic Kimmeridge formation at a depth of between 2,500ft (762m) and 3,000ft (914m).

It describes this as a "world class potential resource" and that the well has the "potential for significant daily oil production".

Compared with similar geology in the US and West Siberia, it estimates that 3% to 15% of the oil could be recovered.

Underground riches

Oil has been produced onshore in the South of England for decades. There are currently around a dozen oil production sites across the Weald, a region spanning Kent, Sussex, Surrey and Hampshire.

Last year, a report for the government by the British Geological Survey estimated that the region may have shale oil resources in the range of 2.2-to-8.5 billion barrels, with a central estimate of 4.4 billion barrels of oil.

UKOG says that it drilled the deepest well in the region in the last 30 years and that the results "comprehensively change the understanding of the area's potential oil resources".

"Based on what we've found here, we're looking at between 50 and 100 billion barrels of oil in place in the ground," says Mr Sanderson.

"We believe we can recover between 5% and 15% of the oil in the ground, which by 2030 could mean that we produce 10%-to-30% of the UK's oil demand from within the Weald area."

'Significant'

Work currently under way at Imperial College also suggests that there may be more oil in the region than previously thought.

Professor Alastair Fraser has used some of the most sophisticated equipment in the world, based at the University of Utah in Salt Lake City, to analyse rock samples.

His study of a third of the Weald came up with a resource of 13 billion barrels.

"So if I scaled that up, we are coming up to numbers of 40 billion barrels," he told the BBC.

"Now that's getting significant. That's a resource. That's what's there in the ground. We've still got to get it out."

Fracking unnecessary

Most experts believe fracking, or hydraulic fracturing, will be needed to get commercial quantities of oil from the region.

Concerns over fracking led to large-scale protests when Cuadrilla drilled at Balcombe, West Sussex, in 2013.

But UKOG has consistently stated that it is not intending to use fracking, which involves pumping water, sand and chemicals into rocks at high pressure to liberate the oil and gas trapped within.

It says that the oil at Horse Hill is held in rocks that are naturally fractured, which "gives strong encouragement that these reservoirs can be successfully produced using conventional horizontal drilling and completion techniques".

The company says further drilling and well testing will be needed to prove these initial results.

On Yemen - The US isn’t winding down its wars – it’s just running them at arm’s length

Seumas Milne in The Guardian

So relentless has the violence convulsing the Middle East become that an attack on yet another Arab country and its descent into full-scale war barely registers in the rest of the world. That’s how it has been with the onslaught on impoverished Yemen by western-backed Saudi Arabia and a string of other Gulf dictatorships.

Barely two weeks into their bombardment from air and sea, more than 500 have been killed and the Red Cross is warning of a “catastrophe” in the port of Aden. Where half a century ago Yemenis were tortured and killed by British colonial troops, Houthi rebels from the north are now fighting Saudi-backed forces loyal to the ousted President Abd Rabbu Mansour Hadi. Up to 40 civilians sheltering at a UN refugee camp in the poorest country in the Arab world were killed in a single Saudi air attack last week.

Somalia lends support to Saudi-led fight against Houthis in Yemen

 

Read more

But of course the US and Britain are standing shoulder to shoulder with the Saudi intervention. Already providing “logistical and intelligence” support via a “joint planning cell”, the US this week announced it is stepping up weapons deliveriesto the Saudis. Britain’s foreign secretary, Phillip Hammond, has promised to “support the Saudi operation in every way we can”.

The pretext for the Saudi war is that Yemen’s Houthi fighters are supported by Iran and loyal to a Shia branch of Islam. Hadi, who was installed after a popular uprising as part of a Saudi-orchestrated deal and one-man election in 2012, is said to be the legitimate president with every right to call on international support.

In reality, Iran’s backing for the homegrown Houthis seems to be modest, and their Zaidi strand of Islam is a sort of halfway house between Sunni and Shia. Hadi’s term as transitional president expired last year, and he resigned in January before fleeing the country after the Houthi takeover of the Yemeni capital Sana’a. Compare Hadi’s treatment with the fully elected former president of Ukraine, whose flight from Kiev to another part of the country a year ago was considered by the western powers to have somehow legitimised his overthrow, and it’s clear how elastic these things can be.

But the clear danger of the Saudi attack on Yemen is that it will ignite a wider conflagration, intensifying the sectarian schism across the region and potentially bring Saudi Arabia and Iran into direct conflict. Already 150,000 troops are massed on the Yemeni border. Pakistan is under pressure to send troops to do Riyadh’s dirty work for it. The Egyptian dictator Abdel Fatah al-Sisi has said he will despatch troops to fight in Yemen “if necessary”.

The Houthi uprising, supported by parts of the army and Hadi’s predecessor as president, has its roots in poverty and discrimination, and dates back to the time of the US-British invasion of Iraq more than a decade ago. But Yemen, which has a strong al-Qaida presence, has also been the target of hundreds of murderous US drone attacks in recent years. And the combination of civil war and external intervention is giving al-Qaida a new lease of life.

For the Saudis, Yemen is about enforcing their control of the Arabian peninsula and their leadership of the Sunni world

The idea that the corrupt tyranny of Saudi Arabia, the sectarian heart of reaction in the Middle East since colonial times, and its fellow Gulf autocracies – backed by the Israeli prime minister Binyamin Netanyahu – are going to bring stability, let alone freedom, to the people of Yemen is beyond fantasy. This is the state, after all, that crushed the popular uprising in Bahrain in 2011, that funded the overthrow of Egypt’s first elected president in 2013, and has sponsored takfiri jihadi movements for years with disastrous consequences.

For the Saudis, the war in Yemen is about enforcing their control of the Arabian peninsula and their leadership of the Sunni world in the face of Shia and Iranian resurgence. For the western powers that arm them to the hilt, it’s about money, and the pivotal role that Saudi Arabia plays in protecting their interests in the oil and gas El Dorado that is the Middle East.

Since the disasters of Iraq and Afghanistan, the US and its allies are reluctant to risk boots on the ground. But their military interventions are multiplying. Barack Obama has bombed seven mainly Muslim countries since he became US president. There are now four full-scale wars raging in the Arab world (Iraq, Syria, Libya and Yemen), and every one of them has involved US and wider western military intervention. Saudi Arabia is by far the largest British arms market; US weapons sales to the Gulf have exceeded those racked up by George Bush, and last week Obama resumed US military aid to Egypt.

What has changed is that, in true imperial fashion, the west’s alliances have become more contradictory, playing off one side against the other. In Yemen, it is supporting the Sunni powers against Iran’s Shia allies. In Iraq, it is the opposite: the US and its friends are giving air support to Iranian-backed Shia militias fighting the Sunni takfiri group Isis. In Syria, they are bombing one part of the armed opposition while arming and training another.

A tilt towards Iran can be offset with war in Yemen or Syria. Something similar can be seen in Latin America

The nuclear deal with Iran – which the Obama administration pushed through in the teeth of opposition from Israel and the Gulf states – needs to be seen in that context. The US isn’t leaving the Middle East, as some imagine, but looking for a more effective way of controlling it at arm’s length: by rebalancing the region’s powers, as the former MI6 officer Alastair Crooke puts it, in an “equilibrium of antagonisms”.

So a tilt towards Iran can be offset with war in Yemen or Syria. Something similar can be seen in US policy in Latin America. Only a couple of months after Obama’s historic opening towards Cuba last December, he signed an order declaring Cuba’s closest ally, Venezuela, “an unusual and extraordinary threat to US national security” and imposed sanctions over alleged human rights abuses.

Those pale into insignificance next to many carried out by the US government itself, let alone by some of its staunchest allies such as Saudi Arabia. There’s no single route to regime change, and the US is clearly hoping to use the opportunity of Venezuela’s economic problems to ratchet up its longstanding destabilisation campaign.

But it’s a game that can also go badly wrong. When it comes to US support for Saudi aggression in Yemen, that risks not only breaking the country apart but destabilising Saudi Arabia itself. What’s needed is a UN-backed negotiation to end the Yemeni conflict, not another big power-fuelled sectarian proxy war. These calamitous interventions have to be brought to an end.

Inflation falls to 0%: what does it mean for the UK economy?

With average earnings growing by just under 2%, living standards should rise and interest rates should remain low but it’s not all good news

Larry Elliott in The Guardian

Britain is within a month of a period of deflation. When the figures for March come out next month lower energy bills mean that the cost of living will be lower than it was a year earlier.

These are uncharted waters for the UK, at least in the modern era. There have been times when inflation has turned negative but they have been few and far between since the second world war, and there have been none since the move to the consumer prices index as the preferred yardstick.

The general assumption is that this is good news, for two reasons. The first is that the fall in inflation boosts living standards, because wages are rising faster than prices. Wages have risen extremely slowly since the recession of 2008-09 and even against a backdrop of falling unemployment are currently only going up by 1.6% a year.

But the sharp drop in oil prices in the second half of 2014 has pushed inflation lower and meant those modest wage increases now stretch further. This is clearly welcome news for the government, eager to fend off Labour’s accusation that the coalition has presided over a cost-of-living crisis. The opposition will say that the recent increase in living standards does not make up for the earlier falls.

The second boost to consumers comes from the outlook for interest rates. It will come as no surprise to the Bank of England that inflation now stands at zero, and the Bank’s governor, Mark Carney, has said it would be “foolish” to cut the cost of borrowing in response to what is thought to be a temporary fall in commodity prices.

That said, the Bank is not going to be in a hurry to raise rates either. All nine members of the Bank’s monetary policy committee are in favour of official interest rates remaining at 0.5%, which is where they have been since early 2009. They look like remaining there for the rest of this year, and one MPC member – Andy Haldane, the Bank’s chief economist – says he can contemplate voting to cut borrowing costs.

That’s because there’s a potential dark side to the fall in inflation, namely the risk that it becomes a permanent feature of the economic landscape. The reason the majority of economists view February’s zero inflation as benign is because they think lower unemployment will put upward pressure on wage settlements. Higher pay deals will start to push up inflation at a time when last year’s drop in oil prices starts to unwind. There is, on this view, little prospect of deflation becoming embedded, as it did in Japan.

This, though, assumes that wage settlements are not dragged lower by the drop in inflation. The fact that average earnings are growing at an annual rate of below 2% even after two years of a relatively robust period of growth is indicative of a labour market where employers are able to secure workers cheaply. They may be tempted to be even less generous once inflation goes negative.

Are low oil prices here to stay?

 By Richard Anderson 

Business reporter, BBC News

Predicting the oil price is a bit of a mug's game.

There are simply too many variables involved to make any kind of meaningful, definitive forecast.

What we do know is that, despite a recent upturn, the price of oil has slumped almost 50% since last summer following the longest-running decline for 20 years.

And we know why - US shale oil, and to a lesser extent Libyan oil returning to the market, has pushed up supply while a slowdown in the Chinese and EU economies has reduced demand.

Add to the mix a strong US dollar making oil more expensive in real terms, pushing demand even lower, and you have a recipe for a plummeting oil price.

What happens next is a little harder to see.

With the booming US shale industry showing little signs of slowing, and growing concerns about the strength of the global economy, there are good reasons to suspect that the current slump in the oil price will continue for some time.

This is precisely when Opec, the cartel of major global oil producers, would normally step in to stabilise prices by cutting production. It has done so many times in the past, so often in fact that the market expects Opec to intervene.

This time it hasn't. In a historic move at the end of last year, Opec said not only that it would not cut production from its 30 million barrels a day (mb/d) quota, but had no intention of doing so even if oil fell to $20 a barrel.

And this was no empty threat. Despite furious opposition from Venezuela, Iran and Algeria, Opec kingpin Saudi Arabia simply refused to bail out its more vulnerable cohorts - many Opec members need an oil price of $100 or more to balance their budgets, but with an estimated $900bn in reserves, Saudi can afford to play the waiting game.

Opec now supplies a little over 30% of the world's oil, down from almost 50% in the 1970s, partly due to US shale producers flooding the market with almost 4 mb/d from a standing start 10 years ago.

"Given this scenario, who should be expected to cut production to put a floor under prices?" Opec argued last month.

Equally, Saudi is not prepared to sacrifice more market share while its competitors, not least US shale oil producers, prosper. Safe in the knowledge that it can withstand very low oil prices for the best part of a decade, it would rather stand back and, as Philip Whittaker at Boston Consulting Group says, "let economics do the work".

The implications of Opec's decision, therefore, go way beyond sending the oil price crashing even further.

"We have entered a new chapter in the history of the oil market, which is now starting to operate like any non-cartel commodity market," says Stuart Elliott at energy specialist Platts.

The fallout has been immediate in many parts of the industry, and promises to wreak further havoc in the coming months and, quite possibly, years.

'Serious risks'

Without Opec artificially supporting the oil price, and with potentially weaker demand due to sluggish global economic growth, the oil price is likely to remain below $100 for years to come.

The futures market suggests the price will recover slowly to hit about $70 by 2019, while most experts forecast a range of $40-$80 for the next few years. Anything more precise is futile.

At these kinds of prices, a great many oil wells become uneconomic. First at risk are those developing hard to access reserves, such as deepwater wells. Arctic oil, for example, does not work at less than $100 a barrel, says Brendan Cronin at Poyry Managing Consultants, so any plans for polar drilling are likely to be shelved for the foreseeable future.

World's top oil producers, 2014 (million barrels a day)

• US: 11.75
• Russia: 10.93
• Saudi Arabia: 9.53
• China: 4.20
• Canada: 4.16
• Iraq: 3.33
• Iran: 2.81
• Mexico: 2.78
• UAE: 2.75
• Kuwait: 2.61

Source: IEA

North Sea oil production is also at serious risk, certainly in terms of new wells that need an oil price of about $70-$80 to justify drilling. Indeed in a recent interview with Platts, the head of Oil & Gas UK said at $50, North Sea oil production could fall by 20%, dealing a hammer blow not just to the companies involved but to the Scottish economy as a whole.

Exploration into unproven reserves in regions such as Southern and West Africa will also grind to a halt.

Questions are also being asked about fracking. Costs vary a great deal, but research by Scotiabank suggests the average breakeven price for US shale producers is about $60. At the same price, energy research group Wood Mackenzie estimates that investment in new wells would halve, wiping out production growth.

"The vast majority [of US shale wells] just don't work at $40-$50," says Mr Cronin.

Oil majors are already suffering, having announced tens of billions of dollars of cuts in exploration spending. But while the share prices of BP, Total and Chevron are all down about 15% since last summer, the majors have the resources to see out a sustained period of low oil prices.

There are hundreds of other much smaller oil groups across the world with a far more uncertain future, not least in the US. Shale companies there have borrowed $160bn in the past five years, all predicated on selling oil at a higher price than we have today. Banks' patience can only be tested so far.

Oilfield services companies are also "feeling severe pain", according to Mr Whittaker, with share prices in the sector down an average 30%-50%. Last month, US giant Schlumberger announced 9,000 job cuts, some 8% of its entire workforce.

But it's not just oil companies that are being hit by lower oil prices - the renewables sector is suffering as well.

In the Middle East and parts of Central and South America, oil is in direct competition with renewables to generate electricity, so solar power in particular will suffer at the hands of cheap oil.

Fuel price calculator 

Elsewhere, falling oil prices are helping drive down the price of gas, the direct rival of renewables. Subsidies, therefore, may have to rise to compensate.

Indeed lower oil and gas prices undermine a fundamental economic argument propounded by many governments to support renewables - that fossil fuels will continue to rise in price.

The impact is already being felt - shares in Vestas, the world's largest wind turbine manufacturer, are down 15% since the summer, while those in Chinese solar panel giant JA Solar have slumped 20%.

Lower oil prices are also a grave concern for electric carmakers, with sales of hybrids in the US falling while those of gas-guzzling SUVs surge.

'Profound impact'

The knock-on effects within the energy industry of a sustained period of lower oil prices are, then, both widespread and profound.

But while Saudi Arabia's decision to call time on supporting the oil price marks an important milestone in the industry, oil's self-stabilising price mechanism remains very much intact - prices fall, production drops, supply falls, prices rise.

As a direct result of lower prices, exploration and production will be curtailed, and while it may take a number of years to filter through, supply will fall and prices will rise. After all, while there may be hundreds of new small suppliers entering the fray, there are still too few big players controlling oil supply for a truly free market to develop.

But real change is on the way. There is a growing realisation that fossil fuels need to be left in the ground if the world is to meet climate change targets and avoid dangerous levels of global warming.

Against this backdrop, it is only a matter of time before a meaningful carbon price - hitting polluters for emitting CO2 - is introduced, a price that will have a profound impact on the global oil market.

Equally, for the first time oil is facing a genuine competitor in the transport sector, which currently accounts for more than half of all oil consumption. Electric vehicles may be a niche market now, but as battery technology in particular advances, they will move inexorably into the mainstream, significantly reducing demand for oil.

The oil market is undergoing significant transformation, but more fundamental change is on the horizon.

Global tremors: bure sitare can bring bure din i.e. bad stars can bring bad days

Swaminathan Aiyer in the Times of India

Narendra Modi’s first six months in office reflected “achhe sitare” (lucky stars) more than “achhe din” (good days). But luck can turn nastily. Suddenly, dark global clouds over Russia (and maybe even China) signal the risk of “bure din” (bad days) ahead.

Is last week’s rouble collapse the start of a debacle like the 1997-99 Asian Financial Crisis? Will the Chinese slowdown end in a hard landing? The chances are probably no more than 10-15%, but India could suffer serious pain.

The 1997-99 crisis was sparked by the exit of foreign investors from all emerging markets, causing currencies and commodity prices to crash. Russia and other countries defaulted on foreign debt. The crisis spread globally, exposing all emerging markets as brothers in vulnerability.

Last week, the Russian rouble, once worth 30 to the dollar, collapsed to 70 before recovering a bit to 60. The slide began with western sanctions, was exacerbated by falling oil prices, but became a debacle only when panicky investors (and Russians) began fleeing roubles for dollars. This crisis is one of finance more than oil.

Other emerging market currencies have also fallen, from 5% for India to 15% for Turkey. Crashing oil prices threaten to bankrupt Venezuela and Nigeria. If any countries default on foreign debt, the contagion could infect many emerging markets (as in 1997).

China has slowed from 12% growth to a projected 7.5% this year. Even this estimate looks inflated, says analyst Ruchir Sharma: growth of car and electricity sales is just 2%, and demand growth for steel and oil is zero. This is the biggest reason for the halving of prices of iron ore, coal and oil. China’s high growth boosted all world economies in the 2000s. Its slowdown may sink them.

Indians are delighted with the fall in oil and food prices. Wholesale price inflation is zero. What’s not to like? Alas, if commodity prices fall enough to wreck important economies, panic can cause global finance to flee all emerging markets, sinking country after country. What started as a Thai financial crisis in 1997 snowballed into a gigantic collapse of all emerging economies. This caused India’s GDP and industrial growth to crash, many companies went bust, and the Sensex halved from its peak. The rupee fell from Rs 35 to 49 per dollar between 1997 and 2001.

Today, India and all other emerging markets today are much better prepared to face a financial crisis. They have substantial forex reserves, lower current account deficits and foreign debt ratios, and bigger contingency borrowing arrangements. Yet some (notably Russia, Nigeria and Venezuela) look vulnerable.

West Asian oil exporters are major destinations for Indian exports and labour, so crashing oil prices can mean a steep fall in India’s exports to and remittances from the Gulf. This will be offset by cheaper oil imports, but the equilibrium may be reached at a slower GDP growth rate.

Foreigners find western bond yields very low, and so have invested over $5 trillion in higher-interest bonds in emerging markets like India. But when the local currency begins to depreciate, bond investors rush out: their potential currency losses far outweigh potential gains from higher interest rates. That outflow was evident last week.

Global finance may be poised to exit from emerging markets anyway with the end of quantitative easing and expected rise in US interest rates in mid-2015. Remember, when the Fed indicated higher interest rate in August 2013, a tidal wave of dollars exited all emerging markets. This took the rupee from Rs 55 to Rs 68 per dollar and the Sensex crashed. That panic subsided in a few months. The Fed said it would not raise rates for quite some time. Money flooded back into India and other emerging markets in 2014. Modi’s victory and the promise of reform made India a global favourite, and dollars flowed in.

Can global events now spark another panicky outflow of 2013 magnitude, driving down the rupee and stock markets? It’s possible, though not probable. Of the $43 billion of foreign financial inflows in 2014, $36 billion went into bonds. So a bond outflow could be very large. India is much better paced to withstand this than it was last year, yet could suffer a lot.

Let’s not overdo alarmism. Today’s financial panic may subside and be reversed, just as in late 2013. The US Fed may decide not to raise interest rates in 2015 given ultra-low inflation. So, emerging market currencies and stock markets may rise again.

Yet we stand warned. Optimists like finance minister Jaitley predict 6.5% GDP growth for India next year.

But none should assume a painless upward path. We can hope for achhe din, but must prepare for the possibility of bure din.