Albert Einstein once wrote that “the definition of insanity is doing the same thing over and over again and expecting different results.” Were he alive today, he would be repeating the line to anyone who would listen, especially the reporters on cable news channels such as CNBC. He might add that the world’s policymakers always approach oil market disruptions in the same way: predicting there will be no impact on prices.
Einstein would then point out that the policymakers are consistently wrong. A hefty price boost has followed every disruption.
The world has experienced nineteen oil market disruptions over the last forty years. In a paper published in March 2018, I chronicled these events and noted that the maximum price increase was predictable. Last Monday, Secretary of State Mike Pompeo initiated the twentieth disruption. The consequences are projected here.
Start, though, with the energy policy insanity. In each of the disruptions since 1973, I have noted the following regarding government officials.
State Department representatives always say something like “the US Department of State remains in contact with our partners to reduce the risk of supply disruptions. There is sufficient oil supply in the global markets that countries can access.”
OPEC officials always spout some version of “the oil market remains well-supplied, with the recent price driven by geopolitics, not fundamentals.”
Nothing has changed. Last week Reuters offered this quote from the State Department’s Brian Hook, the person running the Iran sanctions program:
“There’s roughly a million barrels per day (bpd) of Iranian crude (exports) left, and there is plenty of supply in the market to ease that transition and maintain stable prices,” said Brian Hook, U.S. Special Representative for Iran and Senior Policy Advisor to the Secretary of State, speaking in a call with reporters.
Meanwhile, Saudi energy minister Khalid al-Falih told Financial Times that Saudi Arabia would not boost production immediately, adding that “the market is ‘well supplied’ and inventories continue to rise despite the sanctions against Iran’s oil exports.”
Mark Twain is thought to have said that “history does not repeat, but it rhymes.” In this case, it repeats. Policymakers have learned nothing in forty years. Related: Rosneft Sees No Oil Deficit Looming As Iran Sanction Waivers End
The table below lists the nineteen market disruptions. I prepared it in 2018 at a time when Conoco had just used an award of $2 billion granted against Venezuela to seize the latter’s assets in Curacao and when production in Nigeria suffered a disruption. For each event listed, the table shows the start date, the duration, the maximum price increase associated with it, and the percentage loss in supply.
(Click to enlarge)
I took these data and developed a model that predicted the price increase associated with seventeen of the nineteen disruptions, excluding the Arab Embargo and the Conoco attachment of Iranian assets. The model explained seventy percent of the price variation. The graph below compares the actual and predicted price changes for each disruption.
(Click to enlarge)
I note here that I based this model on results published in 1982 in Oil Markets in Turmoil, a book I wrote while teaching at Yale. The volume provides a quantitative approach to evaluating oil market disruptions. Related: OPEC Unfazed By Potential Supply Shortage
The findings from the model indicate that the current disruption will likely cause prices to increase sixty-six percent at their peak. Roughly speaking, Brent will rise to between $114 and $126 per barrel.
This conclusion results from my calculation that the present episode will take roughly two percent of supply from the market.
The reduction will come from falling Venezuelan production, which is also subject to US sanctions, the declining Iranian exports, and a modest cut in Libyan exports.
The latest issue of The Economist warns that “the risk of an oil price shock is increasing.” The editors are correct.
Thinking of the Einstein quote above, I end by paraphrasing the title of a great book by Carmen Reinhart and Kenneth Rogoff: “This time will not be different.”
By Philip Verleger for Oilprice.com
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Oil prices are currently underpinned by robust oil market fundamentals such as a strong global oil demand adding 1.45 million barrels a day (mbd) this year over 2018, rock solid Chinese oil imports projected to hit 11 mbd this year, a Chinese economy growing at 6.4% this year beyond the projected 6.3%, a confirmed slowdown in US production and a tightening global oil market caused by OPEC+ production cuts.
These bullish influences will definitely prevail over what I describe as bearish influences such as the failure of US sanctions so far against Iranian crude oil exports, the fact that Venezuela is keeping its oil production steady albeit at a declining rate despite the sanctions and also the fact that the global oil market has already factored in the erratic production in Libya since 2011.
Were the United States to try to block Iranian oil exports through the Strait of Hormuz, the situation could deteriorate very swiftly affecting all Arab Gulf oil exports as well and possibly leading to oil prices beyond $130 a barrel initially not to mention a military escalation between Iran and the United States. This is, however, a remote possibility.
Still, a price of $ 114-$126 could be a godsend to the global economy in that it will invigorate the three biggest chunks in the economy namely, global oil investments, the economies of the oil-producing nations and the global oil industry. One has only to note the huge damage that the collapse of oil prices in 2014 had inflicted on the global industry to realize the importance of relatively high oil prices.
I have always argued that a fair oil price ranges from $100 to $130 a barrel.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London
At $100+ to $130+ oil prices, places like North Dakota will hopefully undergo their third oil boom, and viable technologies to substitute for oil will likely proliferate. In fact, much beyond $75 to $80 per barrel could spell the beginning of economic collapse that will quickly spread world-wide. What good does it do to invigorate global oil investments, oil-producing nations, and the oil industry if all the rest of the world's economy is then spiraled into global economic collapse as a result? Food producing nations such as the US, would need to double and triple the cost of food consumed and exported to other nations. With 1/6th of the world's population, we produce nearly 2/3rd's of the world's food. It is time to think in terms of the full economic spectrum, rather than just the important oil related facets.
The collapse of oil prices in 2014 was in response to the fact that existing economic systems could no longer tolerate the high prices that had evolved. Now that prices have gradually increased from the fallen levels of $35 to $40 per barrel to $60 to $70 per barrel, we have witnessed a leveling in economic productivity, but it will begin to wane again should the increasing per barrel continue. Cause and effect, simple as that. To me the optimal level showed its best at around $60 per barrel, which is much better than $40. The other thing to remember is that all the QE here and abroad was merely a "kick the can down the road" tactic that permanently fixed nothing.
Global economies are still extremely vulnerable. Increasing oil beyond economic tolerance is like stretching a rubber band to the breaking point, resulting in world-wide economic depression. To what good will that exact for all of the oil investors, oil producing economies, or the global oil industry? To consider only those factors seems narrow-minded in view of all the rest of economic society. We must be able to see beyond the ends of our own noses, and into at least the short-term future, but preferably the medium and long-term futures as well.