Brent crude hit an 11-year low of $36.20 last Tuesday, in part because OPEC has ceased to function. So, ding dong, the cartel is dead. By all means sing and ring the bells out. Just not too loudly.
This isn’t, of course, the first time that oil prices have suddenly taken a tumble. Nor would the Organization of Petroleum Exporting Countries be the first oil cartel to go limp. So we — or at least the energy guru and Pulitzer prize-winning author Daniel Yergin — know something about what to expect.
In the short term, the answer is straightforward and zero-sum: Cheap oil is good for growth in consumer economies and bad for producers.
That picture may be more complicated for the U.S. this time, Yergin says, because it only imports about a quarter of the oil it consumes today. That’s down from 60 percent in 2005, before the shale oil revolution really took hold. Equally, much of the job growth in the U.S. in recent years has come from expansion of the shale industry, now endangered by lower-priced imported oil. “Unwind that job creation and you have a real problem,” Yergin says.
Even without this change, though, there would be reason to think hard about how the sudden wealth transfers that extreme oil-price volatility causes will pan out over time. OPEC has rarely been a well-meaning price regulator and was often ineffective; today it controls only about a third of oil output and may not even qualify as a cartel. But an arrangement that truly smoothed out price volatility would be beneficial, even though that would mean higher prices, for example, now. That’s imaginable through the creation a “good” cartel, or governments disciplined enough to raise and lower gas taxes to offset oil’s fluctuations, steadying demand. Each, however, is about as likely as a visit from the real, real Santa.
For oil-consuming countries, low crude prices act as a free tax cut, but they also drive down investment in future output. Capital expenditure in oil gas extraction tends to track the price of oil pretty closely:
When demand bounces back or there’s a supply shock, glut can turn abruptly to shortage and prices can rocket upwards, triggering recession. Think 1973. In that year, OPEC imposed an oil embargo in response to U.S. involvement in the Yom Kippur war and the oil price quadrupled. Annual U.S. growth declined from 5.6 percent in 1973, to minus 0.5 percent in 1974. Says Yergin:
That was a dramatic example, when oil markets were tight, demand was strong, a crisis occurred and the oil price exploded.
Prices then fell back in the 1980s and remained low for years, changing expectations and investment appetite:
As late as 2003, institutional investors were urging oil companies to exercise what they called capital discipline. They were saying: ‘don’t invest heavily, because oil will be at $20 forever.’ Then the very next year prices began their explosive rise. That was because people had been investing for a $20 world and then demand took off, led by the double digit growth in China.
IHS, the consulting group of which Yergin is vice chairman, projects that oil companies around the world will invest $600 billion less in developing new production between 2015 and 2020 than it had been forecasting in 2014, before the oil price began its decline. That’s a lot of cancelled investment and capacity.
This would be great for climate change policy if all the forgone investment shifted to renewables, but it probably won’t, so prolonged low prices and investment in oil capacity runs similar risks today.