Guest Editorial: Aiming for a Better Oil Price
- Abdul Jaleel Al Khalifa (Dragon Oil)
- Document ID
- Society of Petroleum Engineers
- Journal of Petroleum Technology
- Publication Date
- July 2016
- Document Type
- Journal Paper
- 14 - 15
- 2016. Copyright is retained by the author. This document is distributed by SPE with the permission of the author. Contact the author for permission to use material from this document.
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The debate among leaders in the oil and gas industry originally was about the longevity of the down cycle: Would it be V-shaped or U-shaped, or would prices stay low for a longer period? When it became clear that lower prices were here to stay, the debate shifted to its impact. If the down cycle is healthy and beneficial, it should be allowed to take its course. But if it is seen as a tragedy, it should trigger urgent mitigation.
A down cycle is healthy, some believe, because commodity cycles are supply and demand driven. Down cycles trim the fat, boost competition, and differentiate those who are fit to survive. These are the rules of the free market economy, leading to cost efficiency, higher productivity, and greater economic development. Emotions aside, the oil price is determined by the equilibrium of supply and demand, and the consequences of such cycles are realities that the industry must bear. After all, a free market economy is a package deal, and one should expect to see casualties in this journey. The current down cycle will not be the last, and the industry will keep going and continually get healthier over the years. This is the opinion of this camp.
It is a tragedy, others believe, because so far approximately 350,000 employees have lost their jobs and about USD 350 billion worth of capital projects have been canceled or deferred. Many small- to medium-sized companies have declared bankruptcy. Hundreds of drilling rigs are stacked. Many students have decided to change their major away from petroleum engineering. Shareholders, including investors and oil-producing countries, have lost trillions of dollars. Indeed, some governments have approached the International Monetary Fund, World Bank, and the bond market for rescue. This cycle severely impacted unconventional, deepwater, and other renewable resources. The petroleum industry has suffered an immense loss, with far-reaching consequences that likely will result in oil price spikes in the future. This is a summary of this camp’s position.
In his classic book, The Origin of Wealth, Eric D. Beinhocker explained the evolution of economics, strangely enough, by reviewing the basic laws of thermodynamics. Economic theories were developed concurrently alongside the progress of laws of physics.
Traditional economies were based on the first law of thermodynamics (energy is neither created nor destroyed). This applies to a closed system where the boundaries of the system do not allow exchange of energy or matter with the outside. A good physical example is the whole universe. If applied to economics, it means that value is preserved and can only be transformed. Resources are transformed into goods and then into utilities. In other words, wealth is transformed but cannot be created. This law states that supply and demand yield an equilibrium sustainable price.
But this law assumes that people behave rationally; that is, their decisions are based solely on their self-economic interest and not on ulterior motives such as hatred or altruism. According to this law, the balanced price between supply and demand is equivalent to the cost of goods or services that meets the demand of the customers plus a reasonable margin of profit to make the business sustainable. This also assumes that all players work under same circumstances.
But both the assumptions are not valid. Suppliers are sometimes driven by motives other than their self-economic interest. In addition, suppliers may not be working on a level playing field; listed companies are often influenced by market forces and, hence, pursue short-term quarterly results, unlike national oil companies that are able to better pursue long-term strategic interests.
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