The oil crisis of today is often compared with the great oil glut of the 1980s. But demand and supply is no more unbalanced now than it was on average throughout the past decade when the price was much higher. Compared with the flood of oil that hit the markets in 1985, new supplies arriving today are ripples on the water. The world is thirsty for oil. Leading analysts see demand increasing 10 per cent between now and 2020.
Yet across the world, oil executives are watching the price of crude fall — and they are responding by dramatically scaling back their investment plans. Analysts Wood Mackenzie estimate that investment in the sector will fall by more than $100bn in 2015. Oilfield services companies have cut tens of thousands jobs over the past year, pointing to a steep reduction of demand for their services. Supply will contract, restoring balance within a year.
In 1985, investing in a new well was worthwhile if the oil it produced would fetch between $20 and $30 a barrel. Now, more oil comes from wells that are tricky and expensive to build; the break-even price is closer to $60 or $100.
Look at the market fundamentals and it seems prices should soon rebound to the $60 or $80 a barrel levels that would make it worth building the wells that the world needs. But if markets are distorted, and the rebound takes longer than it should, many current production projects will be mothballed — and the price will eventually climb to $90 to $110 a barrel, or higher.
In today’s distorted oil markets, prices do not reflect reality. They are driven instead by financial speculation, which outweighs the real-life factors of supply and demand. Financial markets tend to produce economic bubbles, and those bubbles tend to burst. Remember the dotcom bust and the subprime mortgage crisis? Furthermore, they are prone to manipulation. We have not forgotten the rigging of the Libor interest rate benchmark and the gold price.
The answer might seem to lie in more regulation. In fact, regulation is already excessive and makes things worse. The US has banned the export of oil for more than four decades, giving American oil refineries an unfair advantage over their European peers. The excise regime in the EU, which imposes levies on petroleum-based products, distorts oil consumption markets. Sanctions against Iran affect oil supplies and trade balances.
In the long term, sanctions against Russia endanger Europe’s security of supply. The fact that oil is taxed differently in different places further distorts the terms of trade and explains why oil markets in Europe and the US have been structured differently.
Financial bubbles, market manipulations, excessive regulation, regional disparities — so grotesque are these distortions that you might question whether there is any such thing as an oil “market” at all. There is the semblance of a market: buyers and sellers and prices. But they are performing a charade.
What is to be done? First, financial players should no longer be allowed to have such a big influence on the price of oil. In the US, Senators Carl Levin and John McCain have called for steps to prevent price manipulation, though whether they will be implemented, and when, remains an open question.
In any case, the authorities should go further, ensuring that at least 10 or 15 per cent of oil trades involve actually delivering some physical oil. At present almost all “oil trades” are conducted by financial traders, who exchange nothing but electronic tokens or pieces of paper.
We also need international action to make exchanges more transparent and to prevent price manipulation, similar to the measures taken against the Libor manipulators.
Sharing market information, such as production and consumption volumes, prices and contract conditions, would make it harder for price distortions to persist. We should make sure analysts at investment banks do not have hidden conflicts of interest.
A true market for oil, where prices reflect demand and supply, is in the interest of producers and consumers alike. They should work to create one.
The writer is chief executive and chairman of the management board of OJSC Rosneft
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