In August and September 2010, Chinese coal convoys caused the largest traffic jams ever — though no-one present cheered that achievement. Three weeks later the Brazilian multinational Petrobras set its own world record, raising US$70 billion in equity and Brazilians, characteristically more fun-loving than Chinese truck drivers, samba-danced in triumph. In hindsight those two distant events might have signaled a zenith in the oil market. Both demand and supply have conspired, like the proverbial perfect storm, to bring about a dramatic 70% collapse in crude oil prices.
The supply shocks are a well-known story with three central elements: the US shale revolution, the rise of natural gas and renewables, and the aggressive thrust of national oil companies (NOCs) to expand production. With its new cash, Petrobras embarked on an ambitious deepwater program to drill into the thick bedrock of the south Atlantic. The going has been tough. As oil prices fell so did Brazil's NOC, humbled further by a never-ending corruption scandal. The entire market value of its equity is only $15 billion today; its debts are 10 times as much. Petrobras is a victim of both its own missteps and of (what has popularly depicted as) a broader international power struggle between Saudi Arabia, America and Russia. Now, as sanctions are lifted, Iran will expand output into a market already 'drowning'.
The demand-side dynamics are more subtle and will play out over a longer timeframe, but they scare producers more. [fold]
The oil market adjusts to volatile prices by flexibly introducing or shuttering capacity. American shale drillers are especially adept at this tactic. A shrinking pie for everyone else, especially those NOCs who bankroll entire countries, would aggravate already fraught fiscal cases. Accustomed to reliable trend oil growth of 1-2% globally (and 2-3% in non-OECD markets), NOCs can today barely cope with competition from each other, let alone the prospect of a plateau in demand. For that is surely on the horizon; 'peak oil', set in the context of demand not supply. The likely culprits: changes in China; the rush by auto makers and regulators to improve fuel economy; and global climate change mitigation, bolstered by the COP21 agreement struck in Paris last year.
Just this week Exxon Mobil cut its long term forecasts for China; one more indication that crazy 2010 truck jam in Hebei forewarned China's 'peak diesel' moment. Freight volumes in China, a closely watched measure, are falling. Coal cargoes from Inner Mongolia and Shanxi moved onto electrified railways. Sinopec, the state refining company, is quietly warning investors that it will never sell diesel like before. Its surplus diesel exports are rocketing. This fuel, already in the doghouse, accounts for 30% of all petroleum use. If it's true there'll never be another China for minerals, the same may also apply to diesel, used to extract and transport much of the world's bulk materials.
Other major uses for oil are gasoline (26%) and jet-fuel (7%). Consumption of automobiles and airline travel should continue to rise with the increasing affluence of emerging market households. Indeed, China is setting ever-higher records of car sales. Crude oil imports into China have been consistently rising as Beijing cheaply fills its strategic reserves. The popularity of cars, and the Chinese love of SUVs, is creating its own problems: pollution, congestion and a dependency on foreign oil that might one day bite back. No large importer can be complacent about that. So the US, Europe and now China are setting surprisingly stringent efficiency hurdles, based on carmakers' corporate average fuel economy (CAFE), requiring up to 50% improvement over 10 years. In effect, regulators are trying to outrun the car fleet expansion with efficiency gains.
Nor is the auto industry being singled out. The aviation sectors have their own emissions targets. The driver behind this of course is global climate change mitigation, now boosted with the COP21 agreement in Paris. While coal remains the larger source of carbon dioxide emissions, final oil demand must suck it up too, despite the joy of a cheap tank. Taxes must drive a wedge between low crude prices and high pump prices. Producer countries are phasing out subsidies.
The oil price will bounce at some point. A Middle East war or a renewed OPEC agreement could temporarily interrupt the present era of abundant crude. But a structural return to $100 per barrel oil is distant if the industry remains caught between the pincers of rising supply and restrained demand. Who knows what geopolitical chaos will come if oil stays down? In the meantime, real economic effects have arrived. Projects worth $1.8 trillion potentially are in jeopardy. The weakest US shale producers are going bust. The 10 largest multinational oil companies have lost almost $800 billion in market value.
This carnage may explain the puzzling absence of beneficiaries from a lower oil price, which overall should be a net positive for the global economy. Yet peak oil demand might suggest a more ominous growth outlook. Also the speed and shock of adjustment have adverse effects when emerging market oil exporters are 'thrown into chaos.' And they are large customers of everyone else, especially China. Even the US, where low prices are always welcome, has seen muted impact. With prices down 70%, there is wealth redistribution from producers to consumers worth a staggering US$2.4 trillion annually (based on IEA global demand of 95 million barrels per day and a $70 fall in per barrel price). But, perhaps remembering the hubris of 2010, few are celebrating.
Photo courtesy of Flickr user Global Panorama