Where will oil’s wild ride take us? Rice experts available for comment

David Ruth
713-348-6327
david@rice.edu

Where will oil’s wild ride take us?

HOUSTON – (Jan. 8, 2015) – How low will oil and gas prices go? This week oil dropped below $50 a barrel, and many Americans are paying less than $2 a gallon at the pump. Low prices are seen as good for consumers, but the price can send shivers down the spine of the energy industry. Rice University experts weigh in on the current situation and offer what might be in store for gas prices and the economy.

Kenneth Medlock, senior director of Rice University’s Baker Institute Center for Energy Studies:

“Oil markets are very dynamic and price has never been stable at any particular level for a sustained period of time. Demand trends, new supplies, OPEC decision-making, regional conflicts and production disruptions, the value of the U.S. dollar and the upstream cost environment all play a critical role in determining the price of oil and other internationally traded commodities. It is never one thing but a combination of them all, and the past six months are no different.

“One can think of various factors, such as production cost and demand growth, as setting the long-term price, while a host of other things generate volatility in the short run. It is likely that prices will eventually rebound, reflecting the cost of production, but the near term is set up, absent an unforeseen event, to see oil prices remain relatively low.

“This will have implications for U.S. producers and likely trigger some asset sales, but the oil in the ground is not going anywhere. Thus, the future supply picture for the U.S. remains relatively strong. For consumers, lower oil prices typically generate positive economic impact, so the U.S. is potentially on the cusp of seeing relatively robust growth.”

Jim Krane, fellow of energy studies at Rice University’s Baker Institute Center for Energy Studies:

“The global oil market is usually described as a bathtub, with producers adding to supply in the tub and consumers draining it out. But this image doesn’t account for the slow reaction of suppliers or consumers to market signals or the strategic thinking of competing players in the market.

“When the market is fully supplied and signals tell producers to reduce production, these signals can take months to translate into action. In the meantime, a surplus of oil builds up and prices fall, often past the point that is warranted by the cost of production. It also takes a while for consumers to react to these prices, for instance, by buying more or bigger vehicles.

“This is what is happening now. Oil prices have fallen below the average global cost of production of around $60. At some point, supply and demand will rebalance. Discounted oil will rekindle stagnant global demand. And producers will eventually cut back as fewer wells are drilled, offshore projects are deferred and flow from existing wells falls off.

“One interesting aside from the plunging prices is that the ‘swing supplier’ role currently held by Saudi Arabia may devolve to U.S. shale producers.

“Saudi Arabia and other big producers, including Russia, have been unwilling to cut production and prop up prices, since they don’t want to cede market share to North American shale and tar sands producers. That means the swing supply role is shifting by default to North American shale producers by dint of the high rates of decline in flow from shale wells.

“Since shale oil production requires continuous drilling to maintain a constant rate of production, if drilling falls off, production soon follows. The number of drilling rigs operating in the U.S. is dropping at its fastest rate in five years. Shale exploration is slowing. At some point production should also drop, and supply flowing to markets will fall off. However, shale producers are nimble. When oil prices rise again, expect them to return to the field.

“In this sense, U.S. shale business is fundamentally different than conventional oil production. It’s more of a manufacturing process, where production can be quickly ramped up or down according to market signals. Conventional oil requires big exploration and development processes involving huge investments and fields that typically produce at near-constant rates for years.

“Before OPEC consolidated its dominance of production in the early 1970s, the role of global swing producer was held by Texas, overseen by the Texas Railroad Commission. We may see that role return, but in a less formal way. It may not be production quotas like those in the pre-OPEC era that cause shale production to rise and fall, but oil prices and relative costs.

“Instead of the dominant members of the OPEC cartel taking supply off the market, falling prices may instead force the competitive U.S. shale industry to limit production.”

Bill Arnold, professor in the practice of management at Rice University’s Jones Graduate School of Business and formerly Royal Dutch Shell’s Washington director of International Government Relations and senior counsel for the Middle East, Latin America and North Africa, is currently in London meeting with officials at Windsor Energy:

“I think even experts are in shock at the extent to which prices have collapsed and struggle to get behind the basics of supply and demand to understand the fundamental drivers. 

“Price estimates have been guesstimates all too often. A decade ago DOE (the U.S. Department of Energy) published estimates that prices would not get above a high scenario of $35 through 2025. 

“The majors seemed to be taking a measured approach, with 20 percent cutbacks announced in capital spending. But many of those decisions were made just weeks ago when oil was $70. 

“Small, leveraged independents in shale plays have seen their shares drop in some instances by 80 percent. If prices don’t rise in the next few months, it could get really ugly. 

“There is hope for a rebound, and $70 might look pretty good in 2015. 

“There is probably no industry as dynamic as energy in the sense that every action affects everything else and ultimately leads to a new equilibrium for some period of time. Low oil prices are bad for Russia and Venezuela — and Texas to a large extent. But they also could plant the seeds of recovering prices if today’s low prices reinvigorate flagging economies. But as Lord Howell (Windsor Energy chairman) points out, there is plenty of additional potential production in Brazil, Russia, Iran, Iraq, Mexico, the Arctic, etc., depending on prices and politics.” 

Ted Temzelides, professor of economics at Rice and faculty scholar at Rice’s Baker Institute:

“I would say that the declining oil prices are mainly due to increased supply, as the shale revolution has created unprecedented increases coming from North America.

“OPEC could reduce its own supply, leading to higher prices, but they have been unwilling to do that. It is hard to predict exactly how long this will last. Some OPEC countries can produce at costs that are only a fraction of the costs faced by North American producers, so we could see low prices for maybe up to a year or until increasing world demand catches up.

“Of course, as prices increase in the future, supply will also adjust, so any increase in prices is likely to be moderate in the short run. Low energy prices are good news for virtually everyone, except for the oil industry. … Thus, as energy is a big part of the Houston and the Texas economy, the effects are more mixed for us.

“OPEC needs to find a way to deal with the new competition from North America, and the ‘price war’ we currently experience is a response to this new reality. Overall, world demand will steadily increase, mainly due to growth in Asia, so I do not think that OPEC is going to experience a crisis.

“The Russia/Europe situation has many layers, and it is fairly complex. Clearly, low energy prices hurt the Russian economy. The cooling relationship between Russia and the EU puts a question mark on the reliability of European energy supply. In my opinion, this will likely lead to a larger-than-expected market for potential U.S. energy exports to Europe.”

Media wishing to interview any of the experts should contact David Ruth, director of national media relations at Rice, at david@rice.edu or 713-348-6327.

Rice University has a VideoLink ReadyCam TV interview studio. ReadyCam is capable of transmitting broadcast-quality standard-definition and high-definition video directly to all news media organizations around the world 24/7.

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