There has been a lot of hand-wringing over the recent crash in crude oil prices. Ironically, both environmentalists who want people to stop buying oil and many of the producers who need people to buy more are both challenged by the current price point. To be honest, I couldn’t give a tinker’s damn about the latter, but the former I think have less to worry about than they realize. Renewable energy is an inevitability, and it’s not the price of oil that will drive us there. In fact, I have the sneaking (and again, unprofessional) opinion that the recent plunge in prices will actually help wean us off of oil in the long run, it’ll just take too long, and the entire planet will look like Newark by the time it happens. So, let me explain my unfounded opinions…
This is not the first time the price of oil has crashed, and it wont be the last, but there are forces at play that differentiate this crash from previous ones. These forces may be making oil cheap (for now), but they are making financing oil very expensive, and that combined with declining renewable costs and increased environmental costs will eventually tilt the balance in favour of renewable energy. So, what are these forces I talk about…
I should probably state that I am no means an expert in international capital markets, the oil trade, or really anything outside of Ultimate Frisbee, professional recruitment, and making chicken soup.
- Low Cost vs. High Cost – Quite simply, the low cost producers (primarily Saudi Arabia and their neighbours) can no longer pump enough oil to meet global demand. This effect is hidden a bit by the current glut of oil on the market as high-cost producers continue to pump at a loss, but low-cost producers can no longer supply the majority of the market demand for oil. This isn’t exactly new, their market share has been declining steadily for 30 years in fact, but the disparity is more pronounced than it was at any point in recent history when the price of oil was low. The result of this disparity is that there is very little incentive for oil producing countries to collaborate (or collude) on production quotas: a low-cost producer makes money no matter how much crude costs, whereas a high-cost producers depend on high oil prices to generate revenue; a low cost producer benefits (over the long term) from low prices because they increase their market share whereas a high cost producer benefits from higher prices because that’s where they make their profits. We’re seeing this right now in fact. This results in an reliable supply of oil as each country feverishly tries to compete with each other, both in the market and political sphere. Ignoring the whole “tragedy of the commons” dynamic, the result is political and economic maneuvering (or backstabbing), and the price volatility that inherently goes with it.
- Pumping at a loss – As counter-intuitive as it seems, oil companies in places like the U.S. and Canada need to keep pumping, even when each barrel loses money. Over the past two decades construction and labour costs for oilfields have far outstripped the rate of inflation, and in the past 10 years the cost of borrowing was so low that most advanced oil production fields are heavily leveraged, and with the threat of rising interest rates private producers must keep pumping out barrel after barrel to stay in front of their creditors. Similarly, countries with large nationalized (whether they admit it or not) oil industries must keep pumping because these same countries are often largely dependent on oil revenues to finance their operations, and over the past decade as prices have soared they have become more dependent on this revenue to finance increasingly expensive public policies (e.g., military adventurims in Russia, increased fuel subsidies in Iran), etc. As private producers and national ones try to weather the storm by pumping, they extend the price slump by keeping the market saturated with oil, keeping the wolves at bay for a time but only making them hungrier.
- Crumbling Infrastructure – The infrastructure that supports the oil industry is crumbling in many parts of the world. Countries like Russia, Iran, Venezuela, and even producers in North America and Asia require massive injections of capital to increase or even maintain their current production levels. Canada needs pipelines, Iran needs refineries, Iraq needs pumps, Venezuela needs… well, everything. The list goes on and the numbers are staggering. In short, the countries that can least afford to spend more money on their oil production (and are dependent on high prices) require the most money to stay in the market; this of course doesn’t directly affect what the market will pay for oil, but it sure as hell impacts the cost to produce it.
What do these three things add up to? In a word: instability. Production levels are set to rise and fall, not under the guidance of cartels but unpredictable forces like the reliability of producers that are using outdated equipment, political conflicts, economic sanctions, attempted market interventions, etc. In short, the oil market has become substantially more risky at a time when investments in alternative energy has become decidedly less risky and more lucrative.
Now, this doesn’t mean that banks are going to start lining up to finance solar projects, or car companies are going to start building EVs left and right, but it does mean that increased pressure on the oil industry, pressure that it has no way to respond to. As oil becomes more expensive it becomes less attractive, but as it gets cheaper it makes it harder for the industries that use it to secure a stable, reliable supply. In the end we will eventually wean ourselves off of it entirely. I’m still skeptical that we’ll do it in time, but the price of oil will not be the deciding factor. The dynamics of the oil market, while still constrained by supply and demand, can no longer be predicted with any certainty, and over time fewer and fewer people and industries will expose themselves to those risks when increasingly viable alternatives exist.
At least that’s how I see it.
This is cross-posted with minor edits from something I published on LinkedIN last year.