Lord John Taylor of Warwick, Endeavour Magazine, oil prices

Will it be Oilright?

Lord John Taylor of Warwick, Endeavour Magazine, Oil

“Will It Be Oilright,” written by Lord John Taylor of Warwick.

Government ministers are experts at saying dumb things. On 20 January, in a House of Commons debate about the oil industry, David Mundell MP stated boldly: “We can deal with the volatility of oil prices and continue to provide the stable regime that is so important to the industry”. Just 48 hours later the death of King Abdullah of Saudi Arabia provoked an immediate rise in oil prices and sent the markets into a turmoil of uncertainty. So, oil attempt to analyse the politics of this industry and prospects for the future.


From 2010 until mid 2014, world oil prices had been fairly stable, at about $110 per barrel. But since June prices had more than halved. Brent crude oil dropped below $50 a barrel for the first time since May 2009, while US crude dropped to below $48 per barrel. There are two main reasons for the drop in oil prices. First there has been a lower demand in many countries due to decreased economic growth. Second has been the surging American production of oil. US production is at its highest in almost 30 years, due to the relatively new procedure of Fracking. Gas and oil is extracted from shale formations, using hydraulic fracturing. Then OPEC (Organisation of the Petroleum Exporting Countries) decided not to cut production, as a way to prop up prices. But this worldwide glut of oil inevitably drove down prices.


The declining prices created winners and losers. The winners have been consumers. A $40 price cut shifts some $1.3 trillion from producers to customers. Big importing countries in Europe, India, Japan and Turkey enjoyed these windfalls, leading to increased GDP. The falling oil price helped to keep interest rates down in Britain and America. This has been a key factor in keeping relatively inflation low in these two countries.


But the losers have been the oil producing countries, whose budgets depend on high prices. The rouble has been falling alarmingly, as Russia’s economic prospects have worsened. Nigeria was forced to raise interest rates and devalue the naira. Venezuela’s economy has also been damaged.


It is Saudi Arabia that remains supreme as the world’s largest oil exporter and OPEC’s most influential member.  Although the Saudis need oil prices to be around $85 in the longer term, they have deep pockets, with a reserve fund of some $700bn. So they have been able to withstand lower prices.  There has been tension within OPEC, especially from other oil producers like Iran and Venezuela, to restrict oil supply to bolster the price. But the Saudis view prevailed.


It was British Prime Minister Harold Macmillan who remarked how “events , my dear boy, events” change things. On 22 January King Abdullah of Saudi Arabia died, aged 90. It could hardly have been a shock, given his age and poor health. But his death sparked an immediate increase in oil prices, despite a swift indication from his successor Crown Prince Salman that there would be no change in policy.  Saudi state television announced that the county’s oil minister Ali al-Naimi would remain in place, as if to emphasise the point.


But the King’s death created enough uncertainty about the future direction of Saudi policy to push up the oil price, after several months of decline. The day after the King’s death Brent crude rose to a high of $49.80 per barrel, although there are signs that the price is now settling back down again to about $47. As well as uncertainty in the market, Saudi Arabia is facing regional tensions. It shares a long frontier with Iraq, where terrorist group ISIS are creating havoc. It also borders Yemen and Egypt, where the Arab Spring revolution had a profound impact.


King Abdullah had introduced some modest reforms during his reign, such as improving educational opportunities for women. But there will be further diplomatic pressure on the regime to improve its civil rights record. Last week I was speaking at events in the United Emirates, only about 300 miles away. I could see in Dubai how Western culture has been embraced into everyday lifestyle. Not so for its neighbours in Saudi Arabia, where women are still not allowed by religious custom to drive or vote.


Despite the uncertainty caused by King Abdullah’s death, experts believe that oil prices will continue to drop. This was the opinion expressed by business leaders attending the Davos economic forum in Switzerland last week.  A key theme of the forum was energy conservation and the environment. How fitting it was then that many of the business leaders attending Davos flew there by gas guzzling private jets.


There was a lot of discussion at Davos about the success of shale gas technology. But since shale-oil wells are short lived (output can fall by 60-70% in the first year), any slowdown in investment could quickly translate into falling production.


This episode in the politics of oil presents the world’s leaders with a unique opportunity to rationalise energy policy. It is the chance to get rid of billions of dollars of distorting subsidies for “dirty” fuels. Instead they could  focus taxes more on carbon use.  Even though fracking has boosted America’s oil output by two-thirds in just four years, the country still bans the export of oil and restricts exports of natural gas. This is a legacy of the oil shortages of the 1970s.  There is still a bewildering array of subsidies for American oil refineries and petrochemical companies. Congress keeps giving money to ethanol producers and has still not reviewed its generous subsidies to the nuclear power industry. The most obvious reform would be to simply remove all the subsidies for producing or consuming fossil fuels. As far as oil price is concerned, the Middle East no longer has us over a barrel. A cheaper, greener and more reliable energy future could be within reach, if we grasp it. Oil be watching.

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