Stronger Oil Cartels Needed Now

Jillian Ambrose explains in this Telegraph article several reasons given by Oxford Professor Dieter Helm why oil prices are expected to stay low. Helm is quoted with this statement:

As prices come down you’d expect producers to supply less – that’s normal economics. On the contrary, in oil as output falls the production goes up. Why? Because the marginal cost of production in the Middle East is around $10 and the marginal cost in Russia is $20. So even at $50 you’re making a profit. And if you’re an authoritarian regime and you need $100 oil to balance the country’s budget while surrounded by radicals and insurgents, then you pump as much as you can.

Even if you’re getting less per barrel, you must get the money to keep your budgets going. And that’s exactly what has happened.

If true, this is rather bad news for the climate. At $100 oil, each barrel results in a $90 profit at $10 marginal cost. At $50 oil, you need to produce more than two barrels to get the same profit. And if you need a fixed income from oil to balance your budget, you will produce more, leading to increasing supply at lower prices.

That in turn leads to even lower oil prices, resulting in a negative feedback spiral with the unintended side effect of increasing CO2 emissions from burning all that oil.

The only way to counter this (which is already happening to some extent over OPEC efforts) is to have a strongly enforced oil cartel keeping supply in check.

Anyway, if Helm is correct in his analysis, obviously it is better for Saudi Arabia to sell one barrel at $100 than to sell two at $50. Their short term profit is higher by $10 in the first case, and they are left with another barrel to sell some time later.

So again, oil producers should join Bill McKibben and start a worldwide effort to keep a strongly enforced ceiling on oil supply.

Another reason for lower oil prices, in Helm’s view, is this:

Suppose you’re sitting in Saudi Arabia: until now you’ve been reasonably confident in assuming that if you don’t pump the oil today it will be worth more tomorrow. But if you believe in my view that oil will be worth even less tomorrow, then what do you do? You pump even more now which will take the price down even further.

Obviously eventually all oil used in transport now will be phased out and replaced by renewable energy. At the latest that will happen when the last barrel of oil has been burned.

But it may happen much faster than the oil industry expected. This may put pressure on prices. And people may want to listen to Helm  and start a big panic sale effort, trying to beat their competitors in bringing the oil to the market while it is still worth something.

This would also lead to lower prices, higher supply and more CO2 emissions.

It is clearly true that over the long term, demand for oil will decline. However, it will never go to zero. Even if there is no demand left for oil as an energy source, it will always. stay useful as raw material in the chemical industry.

The trick for the oil industry is to reduce supply faster than demand. The way to do this is to combine the OPEC effort with the Paris Agreement climate change effort. Restrict supply to keep prices high for producers and to keep CO2 emissions low for the climate.

Everyone wins.