Relief from crude oil prices below $30/bbl is welcome-but not the beginning of a return to normalcy. Events surrounding the crash from which prices now struggle to recover are redefining "normal" for the oil and gas industry.
Markets for oil and natural gas have changed fundamentally. Abundance has replaced scarcity. Unconventional resources, especially shales, make crude promptly available from many sources. With good reason, the Organization of Petroleum Exporting Countries has abandoned supply management. Now all producers must consider price effects when deciding whether to bring new supply to market.
Demand restraint
Demand growth, meanwhile, faces persistent restraint. This partly reflects ever-improving oil-use efficiency and economically motivated fuel-switching. But antioil politics also nibbles at consumption. While economic forces will preclude achievement of radical, "leave it in the ground" goals, a prejudice against fossil energy undergirds official decision-making, manifest in automatic resistance to any accommodation to the expanded use of oil, gas, or coal.
Gas scores highest in political acceptability, of course. Despite upstart demonization of methane, gas demand will grow as a replacement for coal in power generation and as fuel for electricity needed to supplement solar and wind. NGL supplies will grow, too, competing with oil. Energy-equivalent values of oil and gas, all but decoupled for many years, will tend to converge anew at the light end of the oil-product barrel.
A swing of oil and gas markets back to scarcity seems very unlikely without a cataclysmic loss of production. Supply disruption from war or rebellion can happen at any time but is not a healthy or lasting way for markets to balance.
Other changes will steer oil-market recovery in uncharted directions.
Two years of broad-axe cuts to capital spending and payrolls have shrunk the upstream industry. Scores of bankruptcies are deleveraging independent producers. Costs have plunged-but not enough to offset capacity cuts resulting from contraction of the capital base and scuttling of equipment and workers. With one geographic exception, the upstream oil and gas industry will emerge much smaller than before and unable to perform as much work as it could when crude prices were twice their current levels-or more.
The exception is the oil-producing Middle East. Iraq, despite security problems, now produces more than 4 million b/d of crude. Iran is raising output after escaping international sanctions, producing an average 3.66 million b/d in June, according to the International Energy Agency. And the more-stable supply powers of the Persian Gulf-Kuwait, Saudi Arabia, and the United Arab Emirates-maintained or increased drilling during the price slump while rig counts plummeted elsewhere.
Even in those countries, the slump had lasting effects. Facing budget problems, Saudi Arabia and the UAE, joined by Bahrain and Oman, crossed a portentous political threshold by announcing plans to at least partly dismantle consumption subsidies.
Saudi changes
Saudi Arabia went further. In April, the government disclosed a plan to expand manufacturing and lower the kingdom's reliance on crude production. Fiscal pressure rooted in the crude-price slump helps explain these moves. But other motives, certain only to royal insiders, probably are at work. From the Saudi perspective, the future must seem to involve less security from the US, more menace from Iran, and growing exertion by consuming-nation governments to curb the use of oil. Saudi Arabia thus might even be switching strategically from defense of resource-based revenue streams for future generations to liquidation of reserves in support of investment in industries with greater long-term promise. An extra advantage of such a strategy, and the implicit price weakness, is the fiscal distress it imposes on adversaries more dependent on crude sales.
Whatever the motive, the locus of Saudi policy is moving away from the wellhead and deflating official concern about the value of crude. That change has rocked OPEC. And its effects count forcefully among other reasons to believe the oil market has endured more than an ordinary price cycle that happened to be tougher than most.
