Veteran economist and oil analyst Phil Verleger in his latest note has roundly criticised everyone who forecast in recent years that oil prices would keep rising forever; which he says includes just about everyone who has an opinion about oil prices.
He highlights the work of Morris Adelman, an MIT economist who’s little known these days — unjustly, according to Verleger:
Yet for years Morry was one of the most influential economists focusing on oil. His mistake was rejecting the consensus view that world resources were exhaustible while calling Harold Hotelling’s theories irrelevant. His views doomed him to temporary oblivian.
You can probably see where this is going: Verleger segues into the development of US shale oil resources, which has nearly all the pundits (Bernstein Research being one exception) shouting about how new extraction technologies applied to shale reserves will revolutionise US oil production, just as it did for natural gas.
Only, Verleger doesn’t believe that this soon-to-be abundance of oil production will necessarily lead prices to fall in a kind of predictable trajectory.
He hypothesises about what a flood of US oil production might mean for the Gulf OPEC producers:
Professor Adelman often stated that oil prices fall as reserve constraints are broken. He may prove correct. However, lower prices need not be the long-run consequence, at least not all the time.
Instead, the consequences of Adelman’s vindication will more likely be increased price volatility. This will occur because the sharp short-term downward pressure on prices will probably increase political instability in some oil-exporting countries. Periods of low oil prices will undermine existing governments in nations such as Russia, Kuwait, Iraq, Algeria, Nigeria, Iran, United Arab Emirates, and Venezuela. These countries have not used oil revenues to diversify economies and build infrastructure for the post-petroleum future. Instead the monies have gone to fund larger and larger transfer (welfare) payments to mushrooming populations.
Adelman’s vindication will mean these nations must curtail such payments when they are forced to cut sales and production sharply or when prices fall. Political instability will increase as such times.
(Some market analysts assert that the income “needs” of oil-exporting countries will dictate prices. Adelman would say this is “nonsense”. Morry once asked an analyst making such a claim if his bank would double his salary if his income needs rose. The analyst got quite cross but had to admit his salary and bonus were not determined by need. The same is true of oil prices[...]
We’ll cut the excerpt there. Incidentally, we don’t quite agree with that bank salary analogy; it’s true that nearly everyone talks about the ‘needs’ of exporting countries dictating prices, but that’s usually with specific reference to Saudi Arabia, which has for many years been the only swing producer and therefore the only country which can control the price of oil to some degree. If Saudi is no longer the only swing producer, or if US oil production rises so much that the whole concept of a swing producer is diminished, then sure — the Saudi government’s budget’s effect on oil prices will probably weaken.
But his view of a hypothetical Saudi et al response to lower prices and/or production is compelling, in that it doesn’t follow that more prolific US oil supply (if that happens to a substantial and sustained level) will mean lower global prices.
US shale oil abundance: Bernstein vs the IEA - FT Alphaville
Shale oil everywhere… for a while – FT Alphaville
Oil production costs in Goldman’s ‘flatter’ world – FT Alphaville
The Future of Oil – Geology versus Technology – IMF working paper