Published in Dawn, Sunday Magazine, September 6th, 2015
It started as a drop but soon became a heavy plummet: crude oil prices in the international markets winged an extended downward this summer. From around $60 a barrel in June, the commodity plummeted to below $40 at the New York Mercantile Exchange in August. While doing so, it broke several psychological barriers and kept plunging without any respite for eight consecutive weeks. These low price levels were last witnessed in 2009 and were then considered a consequence of the Global Financial Crisis.
This time around, oil finds itself at the other end of the cause-effect axis as most analysts attributed the current meltdown to the demand and supply dynamics — the market economy — rather than justifying it as an aftershock of a financial or a geo-political event. There is little doubt that the recent fall in oil prices has the potential to cause tectonic shifts in global power and wealth undercurrents — ripples of which have already been observed across the international markets.
Till a couple of years ago, such low prices were unimaginable. The world was still awed by the popular End of Cheap Oil theory, which posited that since we had already exhausted a major portion of earth’s fossil treasures, diminishing supplies will not be able to cope up with the ever-increasing demand. In July 2008, oil saw its all-time high of $145 a barrel providing credence to the Peak Oil regime. For much of the subsequent period, crude markets hovered around the historically high range of $80-100 a barrel.
Now, there is an emerging consensus among both investors and analysts that lower oil prices are there to stay. Markets can change directions, but the speed at which bullish shouts in the oil market turned into bearish pleas is nothing short of remarkable. How all that reversed could make one of the most astonishing tales of the century.
The story has been in the making for around a decade.
The first part of it starts with developments in the United the United States, the world’s largest producer and the largest importer — at the same time — of oil and natural gas clubbed together. In the wake of high commodity prices, more expensive but technologically advanced methods of discovering and extracting natural resources became commercially feasible.
The most notable of these techniques, and perhaps the most environmentally controversial, is hydraulic fracturing — a method of penetrating into hard layers of rocks spared during conventional drilling. The method, now known as fracking, coupled with the technique of horizontal drilling revolutionised the American mining landscape and resulted in the massive increase of gas production.
From 1,293 billion cubic feet (bcf) in 2007, gas production from the unconventional shale formations in the United States rose to 11,415 bcf in 2013 showing an astounding growth rate of 44 per cent!
Consequently, Henry Hub Natural Gas Spot Price collapsed to $2.75 per million btu (mmbtu) in 2012, from $8.86 per mmbtu in 2008. On the global level, it led to a gas glut as the US no more needed the Liquefied Natural Gas (LNG) which it had been previously importing mainly from Trinidad, Egypt, Qatar, and Yemen. (Remember the strong lobbying for the import of LNG to Pakistan in the recent past!)
After the success of shale gas, the technology was then applied to produce oil — albeit with initial reservation on the chances of success. Following the gas bonanza, oil production in the United States also rose from 5 Million Barrels per Day (mbpd) in 2008 to whopping 8.7 mbpd in 2014. The American dream of energy independence finally came true —almost!
Theoretically, international crude oil prices should have nosedived during the so called “Shale Boom” in the United States; however, they defied the odds and managed to keep calm until 2014. Two major reasons could be cited behind this apparently counterintuitive behaviour. First, the strong expected demand of commodities from the emerging economies, headed by China, which was thought to compensate the future excess supply. The second was the prevailing geo-political tensions in the oil rich Middle East which kept threatening the oil’s supply side hence stabilising prices.
On the other hand, the roaring growth of oil and gas production in the US continued unabatedly alarming other suppliers, most of whom sit together under the auspices of the notorious Organisation of Petroleum Exporting Countries (OPEC).
Historically, the onus to balance the over-supplied market by cutting supplies, and production, used to fall onto OPEC’s major contributor, Saudi Arabia. Unlike the past, Saudis clearly signalled their aversion to replay that role and decided to defend their market share — providing the story with the much needed twist.
Any remaining doubts on the Kingdom’s strategy waned off when, in December 2014, Mr Ali al-Naimi, the otherwise tight-lipped oil minister of the OPEC power house, was quoted in the press taking a frank position: “If I reduce, what happens to my market share? The price will go up and the Russians, the Brazilians, the US shale oil producers will take my share.”
To some, it was a conspiracy hatched by the United States and Saudi Arabia to arm-twist Russia and Iran, their respective oil rich arch-rivals. Whether it was a scheme or not, the timing of the collapse could not help the cause of the latter duo — one of which had to face sanctions due to the Ukrainian adventure while the other was desperate to get rid of the nuclear programme related economic sanctions.
On July 14, 2015 Iran managed to sign the much coveted nuclear deal with world powers — the United States, the United Kingdom, Russia, France, China, Germany and the European Union — to lift the long imposed trade curbs in lieu of her atomic programme. For oil traders, the repercussion was clear; more supplies are on the way to an already flooded market.
As they say there are always two sides of the story, so in this case also the tale is not complete without the mention of ‘demand’ side! And the demand side account is incomplete without bringing energy hungry China into the equation.
No matter how robust had been the supplies, Chinese appetite always looked to gulp whatever was available in the energy markets. Even sluggish demand in the developed world, mainly due to weak European economy, had been offset by the high Chinese growth rate. Shanghai Stock Exchange, country’s premier bourse, skyrocketed from 2,059 points recorded on June 30, 2014 to whopping 5,165 points on June 8, 2015. Gradient of the Shanghai’s SSE Composite Index during this period could easily be confused with that of the “Sky Ladder” — a stunning 1,650 feet display of fireworks in the sky created by the Chinese artist Cai Guo-Qiang.
However, the euphoria in the market was short lived, as the index collapsed to 2,965 points as early as Aug 25, 2015, despite the all-out effort by the government to arrest the decline. The international press dubbed it as the “Great Fall of China”. For the market, it was a clear sign that Chinese demand will no more be an energy black hole and that the only way to find peace with the burgeoning supply is to cut the price. With that, the to-date story of oil price fall ends.
Along with the oil, questions can also be found in abundance around the oil markets. Have the prices bottomed out? Will Saudi Arabia or any other country cut the production? What is the break-even cost of US shale producers? Is Chinese debacle a result of “Irrational Exuberance”? How volatile will be the prices in the coming days? How far the impact would go? Amid all these questions and uncertainties, the only thing that can be stated with certainty is that the story is not finished yet. Many more chapters are about to unfold, sooner than later, and with an accelerated pace.
For a country like Pakistan, which is a net importer of fossil fuels, and is faced with developmental challenges, this emerging scenario can be turned into a rare opportunity to solve the ongoing energy crisis and to pull out the country from the economic malaise. Infrastructure investment, development of indigenous resources, sustainable energy mix, and equitable pricing are some of the major steps which need to be taken before the window is closed.
Stems of our current energy fiasco, especially of electric power, are mostly rooted in the high cost of input fuel — a consequence of rising petroleum prices in the good part of the 21st century. In the past, we enjoyed our indigenous — read cheap — resources, such as water and natural gas, lavishly used without pondering much about investing into the future.
Ultimately, the Dutch Disease gripped the whole nation quietly, as it does.
In 2012, Dr Abdul Hafeez Shaikh, the then federal finance minister, went to the extent of suggesting that there was no crisis of ‘electricity’ in the country but that of ‘cheap electricity’. Successive governments tried to pass-on the ‘fuel cost’ component to consumers through electricity bills, but failed without exception. Conventional budgetary allocation for subsidies was not enough to bridge the deficit between the cost of electricity generation and recoveries from utility customers.
That gave birth to the notorious circular debt — a sheer misuse of accounting practices and government influence to hide the monetary shortfall in the receivable section of energy sector balance sheets. Low fuel prices provide the policymakers and regulators with the golden opportunity to fix the issue quickly and permanently.
For long term energy security, and a sustainable fuel mix, development of indigenous resources is imperative. A lot of field work, and talks, has already been carried out. This is about time to develop and bring those unutilised coal, oil and gas, and hydro potential online on the fastest track possible. Execution of big projects take more years than that of one democratic term; however, the window of opportunity might close before the next election deadline, therefore, this is also a test of our political leadership to show the vision and disprove the popular notion that only military governments can deliver when it comes to infrastructure investment.
Published in Dawn, Sunday Magazine, September 6th, 2015
