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The future of oil prices

Oct 22,2017 - Last updated at Oct 23,2017

Resilient US shale oil production and accelerating shifts in transportation technologies support dominant arguments that low oil prices will persist for much longer than expected, if not forever.

According to the same arguments, US shale oil producers will continue to impose an upper ceiling on oil prices. In other words, higher oil prices will trigger higher shale oil production and intensified competition among suppliers, which will eventually weigh on prices and drag them back to lower levels.

The pressure placed by the US shale oil on market prices is projected to increase in the coming years, supported by more advanced extraction technologies, which will lower production costs and increase elasticity production to price movements.

"One other implication of technological shifts on future oil prices relates to road transportation, which alone accounts for 50 per cent of global oil consumption."

In this regards, oil is at risk of losing its position as the top component of global energy mix in the coming 10 to 15 years if electrical vehicles penetration follows the same pace of transition from horses to cars at the beginning of last century.

One recent IMF working paper concluded that oil prices will drop to reach $15 per barrel by 2040 (in today’s prices), if electrical vehicles market share reaches 30 per cent in 2030 and 90 per cent in 2040.

For those who underestimate the possibility of such technology-driven drastic shift, the same IMF paper recalls a market study by McKinsey & Company in 1989, which predicted that the number of cell phones will reach 900,000 in 2000. Actually, cell phones in use by 2000 exceeded 120 million.

The possibility that the same paradox will apply to electrical vehicles was recently emphasised by the French and British governments’ decisions to ban sale of Diesel and petrol cars by 2040.

Notwithstanding the convincing arguments that support a dominantly bleak outlook of oil prices, an objective forecast should not refrain from highlighting risks to the odds of prevailing momentum.

Depletion of outstanding oil resources is one upside risk neglected by most analysts, despite credible expectations that it would amount to around 24 million barrels per day in the coming 10 years; about 20 times the current supply surplus, and around five times the astonishing growth in US shale oil production between 2009 and 2014.

Such natural drop of global oil production capacity may lead to supply shortages and upside price shocks, if not encountered by significant new investments in the oil industry. 

Oil investments having decreased by half since 2014, the threat imposed by depletion on global oil supplies should not be discounted, especially amid calls on major oil companies to conduct balance sheet stress tests, similar to ones imposed on banks since 2008.

Taking into consideration depletion and investments, among other factors, when forecasting oil prices, one recent IMF paper concluded that oil prices are likely to overshoot their long-term trend in the coming years.

The same paper points out that information asymmetries and dominant low elasticity levels in conventional oil markets add to the risks of an upside price shock, as such market characteristics tend to convert small supply or demand shocks into large price swings for longer than expected time intervals.

More importantly, it is essential to keep in mind that conventional oil and shale oil producers have no conflict of interest when it comes to oil prices. Both sides have mutual interest in higher oil prices to obtain higher economic yields, especially after price wars proved too costly and ineffective to expand market shares.

Common interests may pave the way for a new coalition between conventional and shale oil producers.

OPEC recent calls on US shale oil producers to accept the “shared responsibility” of slashing oil supplies may be the first step towards such monopolistic coalition that might lead to higher oil prices in the future.

By reconciling upside and downside forecasts of oil prices, it can be concluded that oil’s journey towards its inevitable destiny as the “new coal” remains subject to unpredictable upside shocks.

Governments in oil-importing countries should not drop the possibility of unpredictable hikes in oil prices, and are recommended to adopt counter-cyclical fiscal measures, including enforcement of market pricing mechanisms for energy products and securing new revenue streams to strengthen social safety nets.

In Jordan, it has never been as timely to revamp the electricity pricing mechanism, in order to hedge against potential upside shocks in oil and gas prices.

Bold measures on this front, including the privatisation of NEPCO, will be thoroughly addressed in future articles.

The writer, an economist and columnist, contributed this article to The Jordan Times.

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