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Could current oil prices be the new normal?

Dr. John C. Hulsman

Published: Updated:

True to form, no sooner have sanctions been lifted then Tehran has moved to decisively ramp up energy production, the lifeblood of its struggling economy.

While it will take some months for the Islamic Republic to meet its ambitious goal of increasing oil production by 500,000 barrels per day (bpd), there is little doubt that it will eventually get there, further exacerbating the present over-supply of energy that has so dramatically driven world-wide prices down.

In June 2014 oil stood at $120 a barrel; today the price stands at around $30 a barrel, a precipitous tumble of some 70 percent.

Iran’s latest energy gambit must be seen in the larger context of what is going on in the world’s energy market, and especially, what is driving prices down to unheard-of levels, and what is keeping them there. We can start and easily dispense with the important demand side of the equation.

There is little doubt that American hedge funds would step in and buy up smaller energy companies bankrupted by the Rockefeller strategy

Dr. John C. Hulsman

Apart from booming India, and just possibly China, increased demand simply isn’t on the cards anywhere else in the world. Muted demand would be a challenge to global oil producers, even apart from what is happening on the wild and woolly supply side.

Saudi Arabia, as the swing producer in OPEC, have forthrightly embarked upon what I call the John D. Rockefeller strategy in energy markets. To see off growing competition, especially from the U.S. shale revolution, Riyadh has acted much as the great 19th century American oil tycoon so often did.

Rockefeller would increase his oil production, even enduring significant medium-term economic pain for his company as a result, all to know he could drive his erstwhile competitors out of business, thereby preserving market share.

As Saudi Arabia possesses one of the world’s largest capital reserves, and as high-grade oil can be brought to market from the country more cheaply than almost anywhere, a sustained attack on medium-price producers like the emerging American shale industry makes a great deal of sense, on the surface.

Protecting market share

As such – and despite howls of protest from far more inefficient energy producers like Venezuela – OPEC has yet to blink, maintaining production at near record levels. With tensions between Tehran and Riyadh at their highest in decades, there is virtually no chance that OPEC will agree on meaningful production cuts anytime in the near future.

But if OPEC isn’t blinking, shale isn’t wilting. Despite a sharp fall over 2015 in the number of rigs in use – due to the Saudi Rockefeller strategy – the U.S. managed to sustain production of 9 million bpd over the course of the year. The simple reason for this is that shale drilling has become more efficient as engineers learn how to better work with the new technologies that surround the industry.

It is now estimated that shale drilling is still economical even when the price hits $50 a barrel, a marked improvement in its performance, if still not as economical as Saudi Arabia’s drilling. The other major advantage of shale is that its rigs can be turned on and off like a water tap, and are thus far more price sensitive than the fixed rigs that dominate energy production in the rest of the world.

Because of this, American production can nimbly ebb and flow. So even if the Saudis win their Rockefeller strategy, and drive shale producers to cap their rigs due to the low price over time, as the price then invariably begins to rise, shale will quickly come back on-line. In essence, the shale revolution has put a permanent influence over oil prices.

Further, even if shale companies are driven out of business that is no real hardship for the industry as a whole. The entire history of American wildcatting in the energy industry is about companies dramatically rising and falling, with the inherent value of oil meaning there were always corporate giants ready and eager to take their place.

In this case, there is little doubt that American hedge funds – some of whom have already evinced an interest – would step in and buy up smaller energy companies bankrupted by the Rockefeller strategy on the cheap, waiting to cash in as the price rises. American energy production is largely in private hands, which means that there is always another company ready to step into the energy market.

New normal?

Given all this evidence, there is little doubt that energy prices will remain low, well into the medium term. Global demand is slowing and (barring India) there are no obvious bright spots ahead to power increased energy consumption.

OPEC members are now intent on pursuing their strategy. Iran is coming back online. Shale is not wilting, and is generally proving surprisingly resurgent. All this definitively means that low oil prices are now becoming the new normal.

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Dr. John C. Hulsman is the President and Co-Founder of John C. Hulsman Enterprises (www.john-hulsman.com), a successful global political risk consulting firm. An eminent foreign policy expert, John is the senior columnist for City AM, the newspaper of the city of London. Hulsman is a Life Member of the Council on Foreign Relations. The author of all or part of 11 books, Hulsman has given 1500 interviews, written over 510 articles, prepared over 1280 briefings, and delivered more than 470 speeches on foreign policy around the world.

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