DRILLING INSIDIOUS MYTHS
Praveen Jaiswal dismisses a series of popular but erroneous beliefs about oil
Arthur M. Schlesinger Jnr observed that “science and technology revolutionise
our lives but memory, tradition and myth frame our response.” And as John F. Kennedy said, “the great enemy of truth is very often not the lie – deliberate, contrived and dishonest – but the myth: persistent, persuasive and unrealistic.”
The same holds true for the oil industry where at times, markets move on the basis of myths, assumptions and the grapevine.
So the time has come to unravel some myths that may represent a litany of lies in the form of statements presented as facts to sway opinion while some are simply points of view quoted uncritically – including published statements, which at times demonstrate a lack of research or an understanding of oil economics.
Since the 1970s energy crisis, many myths about the oil industry have developed in political and media circles. Almost all literature on oil markets use words such as ‘collapse,’ ‘crash,’ ‘surge’ or ‘explosion’ to seek attention. However, significant events such as these are rare.
Market movements are founded on logic based on macroeconomic clues. The oil market has come to be defined by several narratives over the past several years – market rebalancing, OPEC versus shale, Russia’s relationship with OPEC, OPEC’s conformity with production cuts and shale’s resilience vis-à-vis lower prices. But these frameworks create a narrow ideology and propagate myths that must be dispelled.
In general, we’re made to believe that OPEC alone is to blame for price shocks. And the foremost myth clouding oil markets is that OPEC’s exit strategy implies a ‘total exit.’ The idea that oil producing nations that come together and strike a deal to cut production are somehow going to exit the alliance is misleading.
There is usually no such exit from OPEC – rather, a continuation of the grand alliance under amended terms. Decisions are based on broader perspectives of managing the market to create stability and encourage long-term investments in oil.
Another myth is that OPEC’s top priority is market rebalancing. Market rebalancing may be the measure but a higher price is the goal. The challenge with a price target is that nobody knows what an optimal long-term sustainable price is so the goalpost keeps shifting.
Different price levels create new supply-demand dynamics; and prices are influenced by more than merely underlying fundamentals. There is also the flip side risk of OPEC tightening its reins too much. Saudi Arabia’s Minister of Energy, Industry and Mineral Resources Khalid Al-Falih has admitted that OPEC may need a more concrete goal and that when it alters its market management strategy, it may well coincide with a new long-term target.
The myth that Russia will end its alliance with OPEC also haunts consumer consciousness at times. However, Russia arguably needs the revenue it accrues from oil sales. Although it is worried about losing market share, budgetary needs force it to come on board OPEC and support higher prices.
Many believe that the battleground is OPEC versus US shale oil and that the former’s foremost mission is to stop the shale train. However, the real target for OPEC is healthy prices to meet its respective member nations’ budgetary needs.
Another myth surrounding oil markets is that US shale is resilient, and has come up with technological innovations in drilling to bring down costs and adapted to a lower price environment. The reality is far from this. According to the Energy Information Administration, the rig efficiency of shale wells (after peaking in 2016) is on the decline. Investors also desire a return on capital and would welcome higher oil prices so their value is maximised.
There are factors causing major unforeseen events and disrupting supply. All else being equal, major movements in the price of oil are caused by the most basic driver of price for any commodity – the balance between supply and demand.
Every increase in demand and attempt to cut supply is being countered by conservative measures that support an outlook of economic growth. Innovations in fuel cells and electric vehicles, and drastically lower solar and wind power costs will certainly pose challenges to the oil industry, forcing OPEC to establish a more cohesive and sustainable price structure.
The biggest myth shrouding the industry is the philosophy that oil is a limited resource and will soon be exhausted. While this is true to some extent, the larger truth is that there’s a lot more oil than one thinks there is. If there’s a free market in energy enabling prices to rise and fall in line with supply and demand, combined with the constant evolution of extraction methods, oil will last until such time as humankind needs it.
Indeed, the oil industry has a vibrant history. Some of the myths were once true but it is now a mature, global, competitive, commodity based and capital intensive industry. It is a challenging but important business that doesn’t deserve sympathy but demands a realistic understanding.