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Oil’s Wild Price Swings Set to Create Global Chaos

Volatility is here to stay — and the political and economic implications will touch us all.

Andrew Nikiforuk 5 Dec

Andrew Nikiforuk is an award-winning journalist who has been writing about the energy industry for two decades and is a contributing editor to The Tyee. Find his previous stories here.

As the current global oil glut shakes up petro states around the world, oil prices are becoming more volatile than Donald Trump tweets.

Neither Canada, now the dumb owner of a marginal 65-year-old pipeline, nor Alberta, a key exporter of bitumen, a cheap refinery feedstock, has paid much attention to this revolution.

As a consequence Canada has no strategy to deal with the new normal of highly volatile oil prices.

Government incompetence explains the hew and cry in Alberta about its overproduction crisis and the various proposals to solve it, ranging from the purchase of rail cars (a bad idea) to the decision to order companies to cut production of heavy oil by about 325,000 barrels a day (a sensible idea).

Alberta’s panic attack is based on the idea that bitumen from the province’s oilsands producers is selling at a discount because of a lack of pipeline capacity.

The reality is that the dramatic 30-per-cent drop in oil prices since the beginning of October, from more than US$70 to US$50, is upsetting oil exporters, producers and markets around the world.

Different kinds of oil fetch different prices, based on their quality and transportation costs. And all are experiencing dramatic price drops. Alberta’s bitumen, a cheap refinery feedstock, is not the only crude languishing during a global market glut.

Refineries in Japan and Korea, for example, scooped up cheap U.S. oil earlier this year.

Texas is replaying the Alberta experience. Overproduction of light shale oil and gas in the Permian Basin in Texas has choked up pipelines and refineries and thereby lowered prices for West Texas Intermediate, much to the dismay of shale oil drillers.

Meanwhile China’s three biggest oil companies, including PetroChina, have lost $79 billion in market value since the beginning of October as oil prices plummeted this fall.

No one expects this growing oil price volatility to end soon, and many analysts suspect the unpredictability is signalling five important structural shifts in the global economy that political leaders have largely ignored.

1. Low oil prices can be a big problem

The physics of energy flows, not money, makes the world go around. The evidence strongly suggests that the last 300 years of economic growth were based on a constant supply of cheap energy.

For the last 150 years the quest for cheap energy has changed the planet. Humans, with the help of fossil-fuelled enterprises, now consume one-quarter of the world’s primary biological production. We have changed the atmosphere and made human beings the world’s number one predator.

As the master resource, oil and its affordability controlled the pace of the global economy and influenced the price of most other commodities. Economic recessions followed high oil prices just as booms generally accompanied low prices.

Societies that can increase energy consumption, such as China and India right now, generate more jobs, support higher salaries and service debt more easily. But societies experiencing declining levels of energy consumption, such as embattled Europe, are having trouble keeping people employed at decent wages. By any measure oil remains a keystone species in the complex ecology of a technological society.

Too much price volatility can cripple the entire global machine, and low prices for oil can trigger even greater disruption, argues Gail Tverberg, an actuary who writes about “Our Finite World.”

Tverberg says the problem is not demand for oil, but increasing problems with the affordability of oil.

“The maximum affordable oil price seems to decline over time,” she writes, as workers struggle with stagnant wages, income inequality and higher interest rates. While high oil prices slow consumption and lead to parked cars, low oil prices can disrupt the ability of oil producers to invest in new production capacity and lead to shutdowns.

Tverberg believes the global economy has entered a period where gyrating oil prices will clobber consumers and producers alike. Prior to the 1970s, oil prices worked for both consumers and producers, she writes. But now “the price that consumers can afford has tended to fall increasingly far below the price that producers require.” Price volatility guarantees that producers will find it harder and harder to assemble the capital they need to grow oil production, let alone service their debt levels.

Higher oil prices won’t solve the problem because they will only depress the global economy further. “The physics tie between energy and the economy makes major energy consumption cutbacks virtually impossible, without risking economic collapse,” concludes Tverberg.

2. Wild volatility emerges as the new normal

Tom Therramus, the pen name of a U.S. academic, argues that oil price volatility is a new cyclical trend that has been increasing rapidly over the last 15 to 20 years.

Writing in the blog Oil-Price.Net, he documents this new development. “Wave-like surges,” or spikes in price volatility, tend to erupt every three or four years like clockwork. In addition stock market volatility tends to follow oil price leaps and falls by six to 12 months.

This new volatility in oil prices is analogous to other trends like the increasing frequency of wildfires in forests destabilized by drought and climate change.

And oil price volatility is as dangerous as a wildfire. “Unpredictability in oil price, resulting from rapid changes (up or down) over short time spans, is bad news because oil, and more broadly fossil fuel, is the commodity that is most essential to the operation of a modern economy,” Therramus writes.

Therramus adds “that the world has not seen a phenomenon of this type previously and that its emergence marks the rise of a new dynamic with potential to shape our economic and political fate. The uncertainty that many of us feel thus may be far from nebulous, but a shared hunch that history’s engines are shifting gears.”

Therramus predicted the current bout of oil price volatility.

The Harvard Business Review now suggests that everyone should get used to “faster, shallower price rotations based on changes in production.”

For more than a decade the Alberta government has known that bitumen pricing is 60 per cent more volatile than prices for higher quality West Texas Intermediate. But it did little to buffer its economy or its industry.

3. The global economy is languishing

Economist Robert Gordon has written lucidly about the decline of economic growth in the U.S. In the world’s first petro state, economic growth has shrunk from 3.2 per cent a year in 1970 to 1.4 per cent in 2016. The author of The Rise and Fall of American Growth argues that the slowdown has been marked by rising inequality, stagnant wages and underemployment among college graduates. Taxi drivers with PhDs are one symptom. So, too, are the declining productivity of agricultural research and medical workers. Similar patterns have enveloped the economies of Japan, Korea and Europe.

Gordon suspects that society has exhausted the possibilities and benefits created by what he calls “the Great Inventions of the Second Industrial Revolution,” such as refrigeration, electricity and jet engines. It is becoming “ever more resource intensive” to find technologies or ideas that may have a major impact on the economy, he writes.

This analysis partly explains why populist leaders from Brazil to the United States now emphasize a return to greatness in their tweets and rallies.

4. The U.S. shale gale is disruptive

The U.S. fracking revolution has played a significant role in creating a temporary oil glut and destabilizing prices. Last summer the U.S. pumped 11.6 million barrels a day as its oil production surpassed Russia and Saudi Arabia. The U.S., still a net importer of oil, hasn’t been the world’s largest crude oil producer since 1973.

This novel increase has largely been achieved by shattering dense shale rocks with the brute force technology of hydraulic fracking.

Fracking requires mountains of sand and lakes of water: both sand and water demands have tripled since 2012. The technology also comes with enormous environmental liabilities including earthquakes, methane migration, flaring, land fragmentation and groundwater contamination.

The fracking of shale deposits costs more than mining conventional oil, and it can’t be done without cheap credit. Early this year the Wall Street Journal estimated that “the companies behind the U.S. oil boom together have spent $265 billion more than they generated from operations since 2010.” Only low interest rates and lax regulations have kept the fracking revolution alive.

Some U.S. analysts predict the shale boom will last until 2040. But other forecasters such as David Hughes and Art Berman predict the shale gale will peak much sooner — within 10 years — due to high depletion rates, increasingly hard to extract resources and high costs.

In the meantime, a global surge in oil production, largely driven by fracking in North America, has disrupted oil markets repeatedly and added to oil price volatility. Overproduction in shale formations contributed to the oil price rout of 2014 and the collapse of oil prices this fall.

If Canada had paid any attention to the shale gale over the last decade, it would have limited bitumen production rather than let regulators rubber stamp one oilsands project after another. Competent politicians would have encouraged limited refining near the oilsands instead of advocating for unlimited pipeline expansion.

5. Costly, hard-to-produce oil means diminishing returns

The quantity and quality of oil produced has changed dramatically, meaning diminished returns for all players. Mining bitumen in the boreal forest or fracking tight oil from the Permian require complex and expensive engineering.

Most of Canada’s bitumen production comes from high-cost steaming operations that use enormous amounts of natural gas (almost one-third of Canada’s annual supply) to boil water to produce steam that is pumped underground to increase bitumen production. In the U.S., about half of all oil production comes from dense shale formations requiring high-cost fracking and horizontal drilling.

Bitumen and light oil from dense shale formations share a common trait — poor quality that adds to the cost of refining them. Bitumen requires upgrading while light oil poses a different set of refinery challenges, including contamination with paraffin waxes and hydrogen sulfide.

French geologist Jean Laherrère notes that shale oil is of substantially lower quality than conventional oil. So an increase in the number of barrels being produced does not mean an equivalent increase in energy value.

The more energy and capital that technological society throws at oil extraction, the more fragile it becomes. A hundred years ago companies drilled a hole and oil gushed from the ground. Now they are smashing concrete-like formations with extreme force or melting oilsands with steam to coax out lesser-quality oil.

In the process, the world’s oil and gas industry has gone further and further into debt to cover the cost of mining these extreme resources.

Low prices and more volatile pricing are not only big problems for the industry, but even bigger problems for oil-exporting states dependent on oil revenues.

Art Berman, the Houston analyst, calculates that the global industry needs a world oil price between $60 and $70 to recover costs. The price today is $50.

What does it all mean?

The lessons from these new realities are complex, but important.

The global economy is failing, with diminishing returns for the 99 per cent. Elites around the world are fighting among themselves over the remaining spoils.

Economic stagnation has plunged oil prices into chaotic volatility. (Or has the irrational pursuit of extreme resources such as bitumen and tight oil helped to unhinge the global economy?)

Canada promoted oilsands production based on forecasts of $100-a-barrel oil. The price reached that level in 2008, and then plunged. Volatility has ruled since. Canada and Alberta have also pretended bitumen, a cheap refinery feedstock, would command the same prices as higher quality oil.

Global markets have delivered the truth. Garbage crude is always garbage crude until you add value by upgrading and refining it. And when prices swing, low-quality oil takes the biggest hit.

Companies can compensate for oil price volatility in the short term by hedging, storing the product or by operating refineries and adding value. Governments can curtail production, as Alberta Premier Rachel Notley reluctantly did. (And yes, the price of heavy oil rallied.)

But the increasing waves of oil price volatility ultimately create political and financial instability. Petro states then practice extreme politics to contain the resulting unrest. And the U.S. is one of the world’s most conflicted and dysfunctional petro states.

Technology does not create energy. It merely accelerates the depletion of resources by providing more complex, costly ways of extracting what poorer hydrocarbons remain.

And no, it’s not just fossil fuel resources that are depleted. Cheap oil lets companies build bigger boats with bigger engines to use bigger nets to catch smaller fish, even as stocks are destroyed.

These energy dynamics also explain the repeated global political failure to face the disruptive anarchy of climate change. Minds conditioned by Titanic economic thinking have lost all connections to traditional instincts for survival, and don’t believe in icebergs.

Just as they ignore the reality that, in the absence of courageous political leadership, complex energy systems, like cod stocks, can collapse without much warning.  [Tyee]

Read more: Energy, Politics

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