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Business News/ Opinion / A time of change for the oil industry
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A time of change for the oil industry

The current rebound notwithstanding, a number of structural factors will affect its future

Illustration: Jayachandran/MintPremium
Illustration: Jayachandran/Mint

The oil industry is a fickle beast. The inflation-adjusted price of a barrel of crude took off in 2004 after decades of stability and rose to stratospheric heights. Record highs were touched, then outstripped; by mid-2008, prices had risen to over $147, with a further rise predicted. It never came. The financial crisis brought uncertainty and yo-yoing prices—and ultimately, the penury of the last two years. It’s a history worth keeping in mind when considering the clutch of recent reports—from Barclays, the US government’s energy information administration (EIA) and energy consultancy Wood Mackenzie, among others—that point to the world’s major oil and gas companies having turned a corner.

The current surge of optimism is, of course, propelled by the Organization of the Petroleum Exporting Countries (Opec)’s November deal to reduce production in 2017 by 1.2 million barrels a day. Traders and speculators bet big on a consequent price rally. By December-end, it seemed a smart bet with prices jumping 30%. Come the new year and oil was eyeing the $60 mark. But prices have since started sliding towards the $55 mark and may fall further yet, with exchange and regulatory data showing, according to the Financial Times, that “the momentum generated by funds has stalled". Attempting to read the tea leaves in these whiplash-inducing market swings would be an exercise in futility. But they do point to the structural factors that will shape the industry’s medium to long term future.

The first of these is the US shale industry. Less than a decade old, it was yet enough of a threat to be one of the reasons behind Saudi Arabia’s attempt to squeeze marginal producers out of business by perpetuating oil oversupply. And indeed, the shale industry did undergo a significant amount of pain over the past two years. But it has one advantage. It’s more nimble than its conventional counterpart: quicker to downsize but also quicker to expand operations, and thus respond to market fluctuations.

According to Barclays, capital spending in the US this year will rise 27%, faster than spending by international oil groups—and that’s with an assumption of oil at $50/barrel. Other estimates predict larger increases in capex; drill rig counts are rising steadily. The past two years have forced the industry to evolve. Companies have emerged leaner and fitter; their cost bases are lower. In short, what Opec cuts, the US shale industry will make up.

The second factor is the diminishing of Opec. That may seem counterintuitive given its success in securing the oil production-cut deal. But consider the repeated setbacks on the way to the deal with a lack of unity—and Saudi Arabia’s inability to force the issue with sanctions lifted on regional rival and major oil exporting nation Iran—as the takeaways. Consider also the fact that there may not be full compliance with the terms of the deal over an extended period of time.

This puts Saudi Arabia in an awkward position. Any oil deal of this nature—and indeed, Opec as a whole—requires an anchor state that has the reserves and economic wherewithal to either ramp up production or draw it down and absorb the hit in order to achieve the desired price level. Saudi Arabia has indicated that it might cut production by more than the agreed-upon quantum if needed. There is a reasonable chance it will need to do this, given the US shale situation and the possible reneging of other parties to the deal on their commitments. But to what extent will it be able to manage the pain, and for how long, given that it is under considerable economic strain? And if it fails to hold the deal together, what does that signal about Opec’s ability to control the oil market?

The final factor is the steady rise in renewables. In 2015, renewable energy overtook conventional energy in term of new installations for the first time, according to the International Energy Agency (IEA). The IEA also expects renewables to account for more than 60% of global power capacity growth over the next five years as the cost of production of solar power, in particular, continues to decline. It’s worth keeping in mind, however, that this is still new territory. The industry’s ability to grow absent subsidies and policy support is suspect; in Europe, investment fell sharply by 21% after clean energy subsidies were withdrawn. And oil demand in major developing economies like China and India will inevitably rise. On the other side of the equation are political pressure centred on climate change, China’s massive investment in renewables, the stated intention of major oil producers like Saudi Arabia and the United Arab Emirates to diversify their economies, and the diversification of a number of oil companies such as France’s Total into renewables.

It is not a coincidence that the terms of the debate are starting to shift from peak demand to peak supply. The issue is still hostage to—in Donald Rumsfeld’s formulation—known unknowns such as Donald Trump’s commitment to climate change efforts and unknown unknowns such as technological progress. But it seems a safe bet that the current revival notwithstanding, the oil industry is unlikely to scale the peaks of the last decade again.

Are the oil industry’s best days behind it? Tell us at

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Published: 17 Jan 2017, 12:21 AM IST
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