A slump in oil prices gives producers a chance to teach governments a lesson in comparative fuel economics.
Having watched crude lose 20% of its value in just a few months, however, producers are busy worrying about the future. Many of them again face the stark choice whether to keep or quit producing. While demand staggers, prices will stay low until enough producers choose the latter option to trim supply. The market seems determined to show who was paying attention to its lesson of the late 1980s: that profit, not price, is the name of the game.
THE PRICE RANGE QUESTION
The question of the day not just for producers but for governments as well is whether this price slump is a structural adjustment or an aberration. Some market observers think technology has reduced finding and development costs to the point that when there's no crisis crude should trade at something like $13 17/bbl instead of $18 22/bbl, as it has in the past few years. On the other side of the question are conditions that help explain current price weakness but should lose effect with time. These include a surge in production from outside of the Organization of Petroleum Exporting Countries, high exports from the old Soviet Union, and the lingering potential for a resumption of Iraqi exports. Furthermore, demand won't always be so languid; falling prices will help see to that.
What is certain is that technology is lowering the break even crude price for a growing number of producers and an increasing volume of production. If nothing else, the trend will tend to prolong price slumps. Even if it doesn't structurally lower crude's trading range, it will incline the market toward the range's lower end. And even if low crude prices meaning prices below the recent trading range are temporary, they serve to highlight the costs of mandates for fuels that cost more.
That's the lesson governments need to hear. The most serious threat to the future of the oil producing business is not price weakness but misguided political pressure to move away from petroleum toward costlier alternatives. Environmental groups exaggerating the effects of oil combustion and governments needing money join forces to seek mandates for nonpetroleum fuels and ever higher taxes on oil. At least in the short term, these pressures help natural gas, which gives producers some consolation. There's nothing wrong with gas or anything else displacing oil so long as the reasons are economic and not political.
The inefficiencies of political fuel selection raise costs across whole economies. The point is perhaps most politically telling in the context of international trade. Countries that require use of otherwise uneconomic substitutes for petroleum or that tax away petroleum's advantages impose costs on their exporters, who must compete with companies in countries that don't manipulate fuel economics. In an era of intensifying international competition, such costs translate quickly into economic harm.
CFV MANDATES
On a narrower scale, the effect is evident in U.S. mandates for sales of "clean fueled vehicles (CFVs)." Prices of fuels deemed clean haven't fallen as much as gasoline prices have recently. The price spread, if it lasts, means a higher cost for the clean fuel preference and diminished marketability of CFVs. This is not to say that a market should not develop for CFVs but rather that a sales mandate is the wrong way to bring it about.
It is time for governments to learn from fuel markets. Oil producers would help themselves by persuading state policy makers to pay attention this time.
Copyright 1994 Oil & Gas Journal. All Rights Reserved.
