The changing political economy of oil

Tony Payne  - Director of SPERI

They also have another strategic aim, which is to damage shale oil production in the US.  The big Arab oil-producing countries are undoubtedly threatened by the booming US oil industry: since 2008 it has led to a considerable reduction in US oil imports from OPEC countries.  The Saudi calculation is that, if returns from oil decline because of lower prices, the US fracking companies, in particular, will eventually have to cut back or even suspend production and further exploration.  This gambit is not certain to work, but it is grounded in the shrewd assessment that, when prices fall, the highest-cost producers are hit first and hardest.  Most assessments reckon that the US shale companies need oil at US$70-80 to break even.  OPEC, in short, is ready to play a long game.

Most of the current discussion of the falling price of oil focuses on these kinds of issues.  It is assumed that ‘business as usual’ will ultimately resume, although along the way there will winners and losers.  As the rouble has tumbled over the last week or so, Russia has been everyone’s preferred candidate for main loser.  In the British context, though, brief mention might just be made of Scotland too.  Its long ‘oil moment’ might just be disappearing before its eyes. 

And yet at this moment do we not need to think bigger and bolder thoughts about the changing political economy of oil?  Is this changing in a more fundamental way?  Would it be good or bad if it was? With his usual acuity, Will Hutton opened up at least some of this terrain in a recent Observer column.  He reminded us of some of the history of the last 30-40 years, noting that ‘in the past rising oil prices were associated with recessions and falling oil prices with booms’.  He went on to forecast that, ‘if the oil price carries on falling back towards $50 a barrel, and if history is any guide, the western economy should respond – to the good’.  

Put differently in old language, a fall in the price of oil on the scale we have lately seen constitutes a huge Keynesian demand stimulus to the global political economy.  Money not spent on oil can be spent on something else.  Hutton saw this and urged European Union governments to challenge the politics of austerity on the back of the fall in the price of oil and launch a major collective stimulus of the Eurozone economy, building on the Commission’s recent infrastructure spending plan.

But who else is talking like this?  And, arguably, even Hutton was too limited in his focus.  The G20, which proclaims itself the world’s ‘premier forum for international economic cooperation’, also met in November in Brisbane.  Its communiqué did focus on growth and it committed G20 members to lifting their collective GDP by at least 2% more than would otherwise have been the case by 2018.  But the methods proposed were just more of the same old ploys to free up supposedly wealth-creating private sectors.  The demand question was ignored and, as for oil, well, the word didn’t even appear in the communiqué!  Say no more.

There also lurks a bigger question still around oil.  This is the necessity that global growth becomes greener and more sustainable, and pretty quickly too, if climate change is to be managed safely.  It’s not difficult to see that more, maybe most, of the oil in the world that has not been burnt needs to stay exactly where it is – in the ground or under the sea.

On this front, falling prices work both ways.  If oil is relatively cheap, there is less of a price incentive to use alternative sources of energy: we are more likely therefore to continue with our oil fix.  But, equally, on this scenario oil companies cannot risk making the expensive investments needed to get to the more demanding (and in the case of shale dirtier) locations where oil is increasingly found.  All oil companies need to attend to their ‘reserve replacement ratios’ and are generally expected to run these at 100%, which means having as much oil in proven reserves as in production.  This is more difficult to assert plausibly when prices are low and costs of production are high.  They face the threat of being left with ‘stranded assets’.

Of course, that may be for the best for the rest of us.  The truth is that we need much more research on these questions.   For example, we need to know the best price for a barrel of oil to cost to enable us to manage most effectively the transition to a greener global economy.  Is it higher or lower than we have at the moment?