SITE 6th Energy Day November 27, 2012
SITE 6th Energy Day – The State of Oil Markets*
The 6th SITE Energy Day was about the current state and future prospects of oil markets, with a particular focus on the crucial challenges faced by the actors in the oil markets †.
Oil is often perceived as a necessary energy commodity from the consumer’s side but also from the supplier’s side. Oil market is usually considered a global and liquid market, at least much more so than the natural gas market. Due to significant technological changes and political events, the oil market’s dynamic is changing. The discussion focused on three crucial points: fundamentals of oil prices, environmental constraints, and politics.
Oil Markets and Prices
Oil prices, as others commodity prices, are deemed to be subject to speculation. Moreover, oil price is commonly used as a reference price for other markets (e.g. natural gas) and therefore it is important to understand the fundamentals of oil supply and oil demand.
Thina Margrethe Saltvedt (Nordea Market) started a discussion with a general description of mechanisms behind oil pricing, distinguishing between more stable long-term forecasts driven by expectations about future supply and demand (in particular, domestic demand of the supplier), and volatile short-term pricing. She also emphasized the role of Saudi Arabia, effectively acting as a swing producer and thus being in a position to influence prices for oil contracts when spare production capacity in the market is insufficient. Adding to this, she continued with the impact of the marginal costs of oil production increasing over time with the maturity of oil fields and having the most significant role in setting of the oil prices.
Bengt Söderbergh (Fortum Trading and Industrial Intelligence) continued the discussion by describing a typical profile of marginal costs structure at a given field. He focused on the importance of the bottom-up approach that systematically collects the data for individual fields, as opposed to a simple use of aggregate data that blend different costs of Greenfield and brownfield assets and misses important intertemporal development of marginal cost structure of individual fields. He also emphasized importance of giant fields in the overall production of oil prices. Since a significant fraction of the giant fields were discovered already by 1980s and now are approaching maturity levels, this effectively raises a question of ease of availability of oil in the future.
Oil Markets and Environmental Constraints
Climate policies that set environmental constraints impact the oil market’s development and need to be assessed.
Conny Olovsson’s (Stockholm University) presentation was about the modelling of the interaction between the economic system and the environment. Since the economic agents do usually not acknowledge negative environmental effects, there exists a scope for government intervention to force the agents to internalize this negative externality. He also questioned traditional models that assume interaction of energy inputs, capital and labour for production.
* By Roman Bobilev (SITE)
† The presentations from the 6th Energy Day are available for download at SITE’s website (http://www.hhs.se/SITE/events/PolicyEvents/Pages/default.aspx)
SITE 6th Energy Day November 27, 2012
According to his estimates, in the short run there is very limited substitutability of energy for capital and labour, and there appears to have been substantial aggregate energy-saving technical change beginning in the 1970s after the oil crisis. This implies that external shocks have limited effect in the short run, but still must be taken into account to facilitate improvements in energy utilization efficiency in the long run. The latter, however, comes at a cost of slowing down increase in efficiency of utilization of capital and labour inputs.
Gustav Krantz (SWECO) discussed the forthcoming implementation of the sulphur EU directive. This directive will apply to European coastal waters and will prohibit the use of fuel with high sulphur content that is used in maritime shipping, forcing a switch to diesel fuel instead. This should have massive implications on the maritime shipping and should increase the demand for diesel fuel. However, European refineries can supply diesel only in limited quantity. Combined with the increase in refining capacities in the oil-producing countries, the EU will have to import more diesel fuel and at higher prices thus straining affected industries even further.
Oil Markets and Politics
Oil markets are inevitably linked to politics. The choice for an oil supplier to explore one oil field or another one is not innocuous and will affect production targets. Moreover, being an oil producer does not necessarily imply a better economic development.
James Henderson (Oxford Institute for Energy Studies) focused on Russian oil production and political factors shaping its prospects. He stressed the importance of the fiscal stimuli that facilitated utilization of surplus brownfield capacities. Russian government was quite successful in providing incentive-compatible revenue tax schemes for that. However, with maturity of the brownfields, increasing marginal costs and declining production, a different profit-based tax setup is needed to facilitate Greenfield investments and diversification of exports markets. Several steps were taken in that direction (e.g. profit-based taxation for oil fields in the Arctic), but the government seems to lack bureaucratic capacity to extend this practice for the industry in. Despite seeming political instability, Russian oil production and exports could remain flat if proper incentive schemes are implemented.
Elena Paltseva (SITE and the New Economic School) discussed whether natural resources, and oil in particular, could hamper economic development of a country. Since natural resources generate sizeable rents, politicians have incentives to build and enforce institutional framework that instead of fostering economic development of a country would entrench the ruling elite in the office and sustain expropriation of these rents. Conversely, if a country has a stable and strong institutional framework that prevents this kind of expropriation, a
“resource curse” can be turned into a “resource blessing,” providing additional funds for development of a country. According to her research, in autocratic countries oil shocks and an increase in political risk for the ruling elite are associated with larger tax havens bank deposits that are originating from the said country, whereas this is not the case for stable democracies.
