There are several demand and supply factors that are causing the current softness in the world price of crude oil which slipped below US$70 per barrel (WTI) this week. These have been building for some time and it may be that we are quickly arriving at a tipping point with potentially significant consequences for Guyana’s economy.
If we start with demand, it is a given that the world economy runs on oil and current forecasts point to a slowdown in world growth for 2024. In the past the severity of recessions in the West has been softened by the strength of China’s and other Asian economies. Take the 2008 subprime market crash that rocked America and Europe. The Chinese government spent 4 trillion yuan in a stimulus package that boosted domestic demand and investment along with imports of raw materials and machinery from the West that helped stabilise their economies.
Even during Covid, China still managed growth thanks in part to massive real estate investments. This again helped stabilise the world economy. However it looks like payback time as debt levels are reaching record highs -372% to GDP. So it is not clear if and when we see a softening of growth in the west, or an outright recession, that China will be there this time. Indeed we may see China falter which would be far more dangerous.
In Europe and America the last two years have seen central banks wrestle with inflation pressures related to Covid supply chain problems and strong consumer spending. That has meant them raising interest rates sharply in order to slow spending. The Federal Reserve increased its target for the federal funds rate by 500 basis points since March, bringing it to a range of 5.25-5.50%. Higher interest rates are meant to dampen borrowing thereby slowing the economy and inflation. It has worked to some extent.
Real estate sales and prices have dropped as financing a home becomes unaffordable. However the American consumer keeps on spending even though they are doing this increasingly with their credit cards. That means at some point spending will slow down. Whatever the case it is safe to say that we are entering a period of slower growth and of course that means slower growth in the demand for fossil fuels.
Finally on the same demand side economists are also beginning to factor in the energy transition when it comes to vehicles and this will only become a bigger factor as more car owners trade in combustion engine vehicles for electric ones. (All forms of transportation ships, airplanes etc account for 60% of oil demand). Some forecasts see oil demand, as it relates to transport, peak by 2030 and decline rapidly thereafter.
In the short term overall oil demand looks soft for 2024. Forecasts range from an increase of 850,000 bpd to 102.45M bpd (U.S. Energy Information Administration) to the Organization of the Petroleum Exporting Countries (OPEC) 2.25 million bpd – 105.75M bpd.
OPEC sees itself as coordinating and controlling the flow of oil from their members so as to maintain stable prices and avoid the booms and busts that are peculiar to commodity sectors. Led by Saudi Arabia along with help from Russia (the plus) they have done well in keeping prices above US$80 per barrel following the Covid crash when prices briefly and nominally hit zero. However the higher price has also encouraged non-OPEC producers to open their taps. Chief among them by far are US shale producers who have contributed in the past year in increasing US production to 12.32 million bpd (shale 7.18m bpd). This makes the US the largest producer in the world.
And it has put OPEC in a familiar predicament where each cut they make to prop up prices has less and less of an effect.
So at the latest OPEC meeting on November 30 to decide on production levels there was some grumbling over more cuts but eventually it was agreed collectively it would amount to 2.2m bpd. However prices still slid on the news to well under the key level of US$80 per barrel for Brent crude. And this is at a time when there are serious geopolitical risks in the very area where oil is transported, what with Israel’s invasion of Gaza.
Something will have to give and this is where we may be reaching the tipping point. That will be when Saudi Arabia and the other low cost producers give up trying to limit supply and instead flood the market; the price plummets, shale producers plug up their wells, supplies go down and prices eventually recover. It has happened several times before, most notably in 2014-2016 when prices tumbled from over US$100 per barrel to below US$30.
What would be the effect on Guyana of a similar repeat? Let’s get the good part out of the way. Cheaper prices at the pump although these seemed to have barely budged in the past two years suggesting there is coordination over pricing among the state operated GuyOil and private distributors. But that’s a story for another day.
The bad news is that oil revenues to the country would drop sharply. Projected production next year is 600K bpd. At US$80 per barrel that is total revenue for the year of $17.5B of which Guyana gets 14.5% or $2.5B. Now do this at US$30 per barrel Guyana receives only US$919M. A big difference.
But perhaps worse news would be the downturn in economic activity. While exploration, development and production of oil would likely go on, the big companies would look to cut costs drastically, and may delay some projects. Oil companies are ruthless when times are bad, and experienced employees understand it’s all part of the business. Meanwhile some of the companies that have just bid on blocks in the auction would find it very hard to raise the money to go into exploration. Very soon we would see a ripple effect in the non-oil economy.
Of course predicting the price of oil is a fool’s game although many people make a living out of it. It’s just worth looking at the big picture sometimes and perhaps guarding against calamities. As we have seen with our neighbour whose current belligerence will also chill investor sentiment, we must hope for the best but prepare for the worst.
