The falling oil price may presage a future recession

Posted on October 17, 2014

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oilprice-datastream

(This is the English translation of my article in the Swedish newspaper Svenska Dagbladet, Fallande oljepris ett tecken på recession)

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Since July the price of Brent crude oil has fallen from $113 per barrel to $85.62 (on October 14). Historically we saw a similarly rapid fall in the in the oil price in late 2008 followed by the start of the global recession the year after. In 2008 the fall from July to December was from $140 down to $40 per barrel. At the moment we see no slowing of the price decline and we do not know how low the price will fall.

The fact that increased global energy consumption is a measure of economic growth means that these recent trends are pointing to an economic contraction. Many economists continue to expect that we will recover from the recession of 2009 and, of course, “growth” was also the hallowed word during the recent Swedish election campaign. We who study Peak Oil in 2008 saw the approaching problem – i.e. that oil consumption was not increasing – and raised a warning flag. In May 2008 members of the Global Energy Systems research group at Uppsala University were invited to the World Energy Forum in Leipzig where, in four separate lectures, we presented our research regarding future oil production. Oil, the fuel that powered the world economy’s growth from the mid-1980s until 2005, then began to decline.

Unrest such as in Ukraine and the Middle East would normally be expected to cause the price of oil to rise but this has not happened. An important reason for this is that Saudi Arabia has built up enormous oil stockpiles. The changes we see in their oil “production” are, in reality, due to release or otherwise of oil from these stockpiles. Thus they can rapidly change their rate of oil sales by millions of barrels per day. To understand the magnitude of this imagine if Norway, with its production of 1.5 million barrels per day, were to go from full production to nearly nothing and then back up to full production again within only a few days.

Compared to 2008 it is now a fact that the USA has increased its own oil production markedly through “fracking”. This new production has meant that the barrel price of US crude oil lies $10 below the world market price. At the same time, the USA needs an oil price of $80 per barrel for fracking to be profitable. The fact that the USA has inflated a production bubble and trumpeted to the world that it will be a larger producer than Saudi Arabia may have frightened OPEC into increasing production to force down the price of oil as a way of putting a stop to fracking. Eagle Ford in Texas is the largest producer of shale oil but if the drilling of new wells there ceases then production from that region will decline by 7.5% per month. The American fracking companies will encounter huge economic problems and it is difficult to predict what will then happen to the vaunted shale boom.

Saudi Arabia needs an oil price of over $80 per barrel to support its domestic budget but that nation’s oil fund is so large that it can absorb losses for several years. The GCC nations, Saudi Arabia, Kuwait, Bahrain, Qatar, UAE and Oman, possess approximately 40% of the world’s remaining reserves of easily (cheaply) producible conventional oil. Their production costs can vary between $5 and $15 per barrel. At the moment the GCC nations account for 25% of world oil production. The fact that they possess a larger proportion of world reserves than their proportionate contribution to current world oil production means that, in the future, production from the GCC will become all the more important for providing oil to the world market.

Economists usually regard mineral resources as a pyramid where the highest quality ores at the top are exploited first. As technology is developed and improved, resources closer to the base of the pyramid that are more difficult to exploit can be accessed. This image has also been used by economists to describe oil reserves. However, the reality for oil is a little different and this means that many economic models make mistaken assumptions about future oil production. At the top of the global oil pyramid is conventional oil and we know now that that the initial available volume of this resource was around 2,200 billion barrels. According to the resource pyramid idea reserves of unconventional oil should be at least double this, i.e. 4,400 billion barrels. The volumes of the unconventional oil reserves are now estimated as: Canada’s oil sands, 170 billion barrels; Venezuela’s Orinoco oil, 300 billion barrels; Shale oil in the USA, 90 billion barrels; oil from deep water, 50 billion barrels and an unknown (but presumably fairly limited) amount of oil in Polar Regions. These unconventional reserves do not even total to 1,000 billion barrels. Oil is produced from these unconventional reserves but requires an oil price of over $70 per barrel to be profitable. The very difficult oil production from the Kashagan field in Kazakhstan requires $120 per barrel. The over-production of conventional oil that we are currently seeing from OPEC may be a way of marginalizing production from these unconventional reserves that generally require an oil price of more than $70 per barrel.

We can speculate regarding the reasons for the rapid decline in the price of oil but we should be aware of the fact that this may signal approaching problems for the world economy. It can be difficult to understand that lower oil prices will cause a recession, but it was the 2008th high oil prices that pushed down consumption and there was a surplus of oil that caused a rapid fall in prices. The International Energy Agency (IEA) has now reduced its prognosis for world oil demand by 200,000 barrels per day on the grounds of reduced economic growth. It is time for our economists to take the concept of limited oil resources seriously. The economic growth rate of 3% that Sweden’s finance minister is hoping for next year could rapidly be reduced to zero.

Kjell Aleklett,
Senior Professor
Global Energy Systems,
Department of Earth Sciences
Uppsala University.

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