Behind the Economics of Oil

Press/Media: Press / Media

Description

A summary of the economics of the oil sector as at early 2013

Period1 Apr 2013

Media contributions

1

Media contributions

  • TitleBehind the Economics of Oil
    Degree of recognitionNational
    Media name/outletResourceStocks Magazine - Aspermont
    Media typePrint
    Duration/Length/Size2 pages
    CountryAustralia
    Date1/04/13
    DescriptionOil is among the most intriguing of commodities to study from a mineral economics perspective. Why? Not least of course because of oil’s principal enabling role in literally fuelling global economic growth. However it is not simply the links to macroeconomic activity levels that make oil so interesting – it is also the intricacies of oil demand and the particular geography and market structure of oil supply.

    On the demand side, oil competes with other energy sources in power provision – principally coal, gas and uranium – but increasingly at the margin with renewable energy technologies too.

    A new example of this competition, and in part collaboration, between oil and renewable energy in the resources sector is the coming provision of hybrid solar power to remote, off-grid, mine sites. Such mine sites in remote locations which currently rely upon diesel oil to be trucked to site for power provision. Those mines that will adopt the new solar-diesel hybrid technology lie in the sunnier climates of the world, notably remote mines across Australia, South America and Africa. Mine managers at this mines can look forward to replacing a fraction of their diesel burn with solar energy each year (presently around 10-15% of the power draw) –provided firstly of course that they install the necessary solar panels – and secondly that the sun still shines! For many this will mean replacing diesel power at say 30 cents per kilowatt hour with a solar hybrid power contribution at around 20 cents per kilowatt hour, saving typical mines of the order of a million dollars a year at currently prevailing prices – and in the process locking in extra stability in power price at least for the solar component.

    Expect oil demand to come under similar demand-side substitution pressure more broadly in its uses if one or more of the following occur: increased oil price, increased short-term volatility in oil prices, greater focus on greenhouse emissions accounting and on-going technology developments in alternative fuels – such as lower net solar power costs in the above remote mines power example.

    On the supply-side, the existence of the OPEC countries in issuing annual supply quotas is a theme of the oil market that is studied extensively by economists. OPEC has assisted in making the supply side of oil a profitable place for producers over the decades. Careful attention is always paid to the guidance of Saudi Arabia on what it considers to be the ‘right’ oil price at a particular time – with current guidance at around the US$100 per barrel mark.

    Similarly, the governments of leading OECD countries have suggested that supply from strategic reserves will also be used to maintain stable pricing around that broad benchmark level should prices escalate.

    Now to the factors driving oil prices in 2013. The United States is lifting its supply – at a time when the OECD countries are still struggling to regain economic traction.

    Demand-side drivers therefore reflect the developing world, notably China’s economic growth, over and above the dampened demand from the OECD countries. So oil joins the ever-growing list of commodities where China holds the key to higher prices.

    The downside to prices appears covered by the development of more marginal fields, with development and operating costs there requiring a floor oil price of around US$85 per barrel. The increased oil output from outside OPEC is taking the tightness out of the market – but spare capacity within OPEC still sits dangerously close to the 2 per cent mark at which minor disruptions to supply could result in spiralling prices. The recent terrorist attack on a gas facility in Algeria highlights the continuing exposure of oil prices to geo-political risks in North Africa and the Middle-East in particular. Production facilities themselves need not be the focus of disruption, the November 2012 skirmishes between Israel and the Gaza Strip for example, lifted crude oil prices by several dollars at the time, even though no physical oil supplies were under threat.

    Economic forecasters are suggesting that the Chinese economy will strengthen further in the first half of 2013, but that China’s growth will again moderate in the second half. With the increase in non-OPEC oil, that suggests an alleviation of the pressure upon OPEC supply capacity by the end of 2013.

    Within OPEC itself, declining Iranian production is expected to be more than offset by increases elsewhere, predominantly in Iraq. Spare OPEC capacity is therefore expected to rise, perhaps back to around 4 per cent last seen in 2010.

    World oil demand received a boost in 2012 from the shutdown of nuclear capacity in Japan. Indeed, Japan alone accounts for one-third of the annual increase in world demand as oil-fired power generating capacity was used to help fill the ‘nuclear gap’ in that country. Having provided a lift in 2012 however, the absence of a further step up in Japan in 2013 will weigh on global demand growth which is expected to rise by less than 1.0 million barrels a day.

    Price stability in oil provides a platform for global economic growth. For consumers it is a case of managing costs in a world of US$100 per barrel oil prices. For producers, profitability is dictated by their share of the revenue from each barrel – versus the share taken by host governments. Short of escalating conflict in the Middle East, 2013 looks set to be a year of relative stability in oil prices.
    Producer/AuthorAllan Trench
    PersonsAllan Trench

Keywords

  • oil
  • economics
  • energy