Power play the reason for oil glut

Saudi Arabia trying to force other producers to back off production

IN my last column we took a look at what had – or had not – happened during 2015 in terms of the proposed northwest B.C. LNG industry.

This time we’re polishing up the crystal ball to see what the next 12 months might have in store.

Any analysis of LNG’s prospects in our backyard has to start with oil since LNG prices have traditionally been linked to those of the black gold.

On March 13, 2012 the price of Brent (North Sea) oil, the international bench mark, shot up to US$126.16 per barrel.

It was of course a blip but on either side of that spike the price stayed steady at around $110: on June 17, 2014 the price was $113.30.

Then the roof caved in and as I write this the Brent price has free fallen by more than two-thirds to only $33.50 per barrel.

So what happened to cause this and what are the prospects of a turnaround?

The answer to the first question is as simple as it is complicated – the available supply of oil has soared as a result of the technological breakthrough (fracking) that has unlocked huge amounts of shale oil in the United States and resulted in an over supply.

In years past when the price of oil slipped, Saudi Arabia and its OPEC partners would simply reduce production in order to force it back up.

Not this time.

The Saudis declared their priority is to maintain global market share so they kept pumping out the oil regardless of the ever diminishing revenue they were getting for the product, a half a loaf is better than none strategy.

Of course there was another strategy at work: drive the price of oil so low that higher cost US producers would be losing money on every barrel they produced at such a rate that they would be forced to either cut back on production or risk going under.

Make no mistake, this strategy is costing Saudi Arabia a pretty penny. Faced with record budget deficits as a result of those declining revenues and its very generous “social contract” commitments to the populace, it has dipped into its foreign currency reserves to the tune of more than $100 billion to keep the financial ship of state on an even keel.

True it still has more than $600 billion in those reserves, but the Saudis have clearly recognized they can’t keep draining them at this pace. Hence the recent decision to jack up domestic Saudi gasoline prices by 50 per cent and talk that they could go so far as to introduce new taxes and even borrow money via the international bond market.

But as painful as these consequences of cheap oil may be for Saudi Arabia, the impact on US oil producers is shaping up to be agonizing, especially since the Saudis have indicated they will not change course before the next OPEC meeting in June.

The Houston Chronicle reported that 70,000 jobs in the US oil industry have already disappeared, unemployment in Houston has risen to 4.9 per cent and drilling in the shale oil plays of Texas and North Dakota has fallen to levels not seen for 16 years.

David Zimmerman of Taltra Capital Management, a company that specializes in “restructuring”, estimates that this year at least one in one in five small-to-medium US oil companies are going to go through significant downsizing at best, bankruptcy at worst.

In other words the Saudi strategy has started bearing fruit.

So what is the outlook for LNG in these turbulent times? That will have to wait for next time.

FOOT NOTE: The oil world was supposed to look very different today from the one we are actually experiencing.

In 1956 Dr. M. King Hubbert, an oil geologist working for Shell, made attendees at an American Petroleum Institute meeting sit up and take notice with his forecast for the future of US oil.

He warned that production in Texas and the Lower 48 states would peak sometime between 1965 and 1971 and that world production would start declining by 2006.

Based on what was known at the time, that wasn’t necessarily a crazy forecast. But events since have shown it is dangerous to predict too far into the future given technological advances can change the rules dramatically.

Former Kitimat Northern Sentinel editor Malcolm Baxter now lives in Terrace, B,C., msdbax@citywest.ca.

 

 

 

 

 

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