Ben Laurance
For a few fleeting moments last Friday, traders on the oil market apparently thought the worst might be over.
Leaders of Opec, the Organisation of Petroleum Exporting Countries, emerged from a meeting in the Hague to declare member states would be cutting oil production by two million barrels a day. The price of North Sea oil jumped, briefly, to more than $13. As recently as last December, the price had been below $10 a barrel.
But will Opec’s cuts really be sufficient to make a big difference to the price of crude? Taking two million barrels a day out of the system sounds impressive. But put this into perspective.
Opec always assures the world that its production cuts will be properly policed. Ali al-Naimi, the Saudi oil minister, declared that “compliance is going to be very high” among the 12 countries involved – the 10 Opec members plus Oman and Mexico.
Well he would say that, wouldn’t he? But Opec targets for limiting output are rarely met. Even the most bullish of oil industry analysts think it unlikely that the agreement will be honoured in full.
And even if Opec did cut the output, the world would still be producing more oil than it consumes. Demand from countries such as South Korea has collapsed, and there is little likelihood of any big upturn in Japanese demand. Even including the cut, global surplus is likely to be 1,5-million barrels a day.
And all this is happening in a heated market. There seems little reason why oil prices shouldn’t go into freefall: with demand outstripping consumption and storage tanks brimming full, why not?
It’s unlikely. The very fact that Opec has done some sort of a deal suggests that the organisation has at least decided not to flood the market and thus wipe out rivals who have to cope with higher production costs.
Imagine that prices remain within the broad area of $10 to $13 a barrel. At those levels, the economics of production from some non-Opec oil exporting countries look decidedly dicey. Take the United States: wells producing some 500 000 barrels a day are no longer economical; a further one million barrels of US production is only breaking even. If crude prices stay low, this output could dry up.
And in the North Sea, the marginal cost of producing a barrel of oil from some of the area’s oldest fields is now close to break- even. Perhaps two-thirds of the oil coming from the Forties, an old field, now flows from “infill wells” – which tap relatively small pockets of crude left after the main wells have been exhausted.
Extracting a barrel of usable crude from these wells is expensive, as it is contaminated with sea water. So if crude prices were to collapse, such production would quickly cease.
At the moment, some 60% of world output comes from 23% of reserves – reserves where production costs are relatively high. Any sharp fall in prices would effectively mean those reserves could not be tapped. And that really would ensure that prices fell no further – whatever was agreed in the Hague last week.