December 4, 2021

The Return of the Bad Old Days

The Return of the Bad Old Days

And we thought the bad old days of oil shocks were over. Embargoes, price spikes, gasoline lines in America, a sweater-bedecked president ordering the end of hot water in many facilities, collapsing retail sales as high gasoline and energy prices hit stores as much as a big tax increase would, economic stagflation, or worse. Well, it just might be that we were wrong to believe that danger to our continued prosperity has been removed with the death of theories about “Peak oil.”

Certainly, the takeover of part of Iraq by ISIS forces, variously called “militants,” “terrorists,” “gangsters,” and in White House circles thought to be disaffected Sunnis aching to participate in the government of a democratic Iraq, has set nerves jangling among energy planners. True, most of Iraq’s oil production, at around 3 million barrels per day the second highest of OPEC’s 12 members after Saudi Arabia’s 10 million, is in the south of the country, still far from the reach of the anti-government forces. But that does not necessarily mean that we can assume recent developments in Iraq will have little to do with the price of crude oil. Oil majors operating in the country have begun evacuating some personnel. Exxon Mobil has removed staff from two large fields in the south of Iraq. That might not shut down those fields, but it will certainly make it imprudent to count on Iraq to increase production in coming years to meet predicted demand increases. Which would mean higher oil prices, never good news for struggling Western economies.

For some time now the International Energy Agency has been warning that continued recovery from the Great Recession is increasing demand for oil and putting pressure on world oil supplies. The IEA is counting on Iraq to supply about 60 percent of the growth in OPEC production in the next several years. That might still happen, but surely it is more risky today to depend on Iraq to increase production by as much as one million barrels per day than it was only a few days ago.

Meanwhile, Libya, which at one time could be counted on for close to 2 million barrels per day, cannot be counted on for much at all as militants have shown they can shut down the nation’s oil transport infrastructure. Russia, with its oil fields ageing and investment-starved, and its production falling off, can’t be counted on to make up any shortfalls. North Sea production is as likely to decline as rise, Venezuela is hardly in a position to meet new demands as its lack of investment and ongoing political turmoil prevent development of its vast reserves, and Mexico remains unpredictable until we see how proposed reforms allowing foreign investment in its inefficient oil industry play out. If we are to avoid the bad oil days, the US and Saudi Arabia will have to push lots of oil onto world markets.

America can do its part. The tale of fracking in the U.S. has been oft-told. As a result of this new technology—really, new applications of an old technology—U.S. daily production of crude oil and associated liquids now exceeds the daily average of some 11m barrels reached in the nation’s peak year, 1970, although production of crude alone, at 8.3m barrels, is short of the 1970s peak. Since 2005, America has accounted for almost all of the increase in worldwide production.

But export of U.S.-produced crude oil is banned by law. So increased domestic production, attainable if the Obama administration does not stifle the growth of fracking as part of the presidential drive to reduce carbon emissions, will be used to reduce imports further and free up those barrels for peddling on world markets.

In Saudi Arabia, the government will have to open the valves to maintain its role as the world’s swing producer and price-stabilizer. Before the new war in Iraq erupted, the Saudis agreed to ramp up production by 300,000 barrels per day to keep OPEC output steady at around 30 million barrels daily, meeting about one-third of world crude oil demand. No sweat, or not much of one. The kingdom will be called upon later this year to add another

400,000 barrels to meet rising demand. A bit of a sweat, but doable. Ironically, Iran is helping to meet world demand by cheating on its agreement, made during the nuclear talks, to put a one-million barrel per day ceiling on its exports pending further negotiations. In the event, the mullahs are exporting 650,000 barrels per day in excess of that ceiling. That nets them about $65,000,000 every day, a nice premium for cheating with no risk that America will walk away from the negotiating table.

All of this means that barring a complete shutdown of Iraq’s industry, there is a rough demand-supply balance, the maintenance of which is in the hands of the Saudis and U.S. drillers. But the risks of a shortfall in the near- medium-term have increased, and with it the risk of higher fuel and gasoline prices that might damage recoveries here and throw the even more fragile euro economies into recession. There are already signs of pressure here on gasoline prices as the driving season begins.

Meanwhile, the markets for the products of crude oil are in turmoil. Although law here prohibits exports of domestic crude, it allows exports of refined products. American refiners have had two recent blessings. First, there is a glut of fracked oil not easily useable in U.S. refineries, and therefor available to refiners at favorable prices. Second, our refineries run on relatively cheap natural gas (another result of fracking). So the oil products they turn out have a price advantage in world markets. Which enables them to send what the trade press calls “a tidal wave” of gasoline, diesel and other refined products to Europe and elsewhere. Which is one reason BP has signed a deal with Kinder Morgan for 80 percent of the capacity of a new Texas refinery that will process U.S. crude just enough to call the output “products,” legally available for export.

As always, sudden change in oil markets has geopolitical as well as economic effects.

·     The administration believes it is in our interests to allow Iran to increase crude sales so as to hold oil prices down and prevent a further slowing of our economic recovery, and to encourage the mullahs to provide military aid to Iraq, and so is accelerating the exploration of common interests with our long-time foe.

·     Any threat of an oil shortage inevitably weakens Israel’s standing with consuming countries, ever-willing to blame any problem on Israel, and increases Saudi clout.

·     Higher oil prices strengthen Russia’s economy.

Then there is the as-yet remote possibility of a complete ISIS takeover of Iraq’s oil fields—that would give the militants control over the price of oil and the fate of Western economies.