The Disappearing Oil Market

barrel.jpgAs the price of oil has just fallen again for the fourth day in a row, dipping below $54 a barrel for NYMEX crude, serious concerns are surfacing in the energy sector over financing for key production and transit projects, which could present a major strain on future supplies.  With the credit tap still turned off and panic over rapidly changing projected cost structures, both technically complicated and politically risky projects are getting delayed – such as the massive oil sands project in Canada, the “Sarah Palin pipeline,” the Petrobras deepwater megafield, and slowing investment to Angola and Nigeria.

Even the implacable Norwegians at the tightly managed StatoilHydro are gloomy, as Chief Executive Helge Lund has commentedI now see more downside risk for our industry than in a long time. (…) The industry’s attention is clearly very quickly shifting from production and growth to cash flow and flexibility…Oil and gas companies all over the world are revisiting plans and investments, and projects are put on hold.

The acrid geopolitics of Russian oil and gas have also been affected, with repeated threatsby Vladimir Putin and Alexander Medvedev to call off the controversialNord Stream project in favor of even more expensive LNG terminals. Although the attempted bluster to hardball and pressure the easily frightened Europeans should be taken with just a grain of salt, there are other indications that the oil price crash could open up some new cooperation and opportunities (even the Chinese may soon hold some serious collateral on Rosneft shares).

But the truth is that it might be too late to see any parity come back, at least not without a significant cognitive shift in how we think about the energy trade.  For all our talk about investment plans, production targets, competition, corporate governance, and competition, we may be inadvertantly granting the oil trade a “market” status when it long ago ceased to function like one.

Although the origins of the current market conditions had their roots well before 11-S, the U.S. invasion of Iraq, and the drastic spike in oil prices which followed, one can really sense that the politicization of the energy trade has become significantly more entrenched since 2003.  This has been largely driven by domestic political developments in producer countries such as Russia, Venezuela, Iran, and Libya, among others, where nationalizations and bureaucratic involvement over the management of the resource sector has grown prolifically.  Just consider for a moment the high number of officials Vladimir Putin’s government, now presided by Dmitry Medvedev, who hold dual posts in the administration as well as at the head of a state owned company.  The same goes for Hugo Chavez’s Venezuela.

But it would be a mistake to assume that the overlapping of foreign policy and resource ownership in these countries were the only factors contributing to the deepening politicization.  The same period has also heralded the quick rise of the so-called NOCs (National Oil Companies), such as CNOOC and CNPC of China, India’s ONGC, Russia’s Gazprom and Rosneft, and many other smaller players in emerging markets.  The NOCs used to be just another player in a vibrantly competitive landscape, and an important client to Western energy companies who could provide project capital, technology and experience for difficult projects, and highly specific services.  Soon, however, these companies began to develop oil services subsidiaries of their own, and the capital gap closed very quickly.

A frequent complaint of mine is that the IOCs (International Oil Companies) appear to fail to understand why the Chinese, Indian, and Russian companies are able to land so many more production licenses and contracts than they are in the developing world – areas of the largest proven reserves.  The answer is that because they approach the deal as both a company and government, they bring incentives to the deal and tied-selling opportunities that no private sector corporation could possibly match – everything from debt forgiveness, infrastructure investment, arms (that’s a Russian specialty), and civilian nuclear development assistance.

There are not a lot of options remaining to consumer nations and private sector players.  The time has come for coordinated action: international legal frameworks and agreements to de-politicize the energy trade, supply diversification, and the formation of a cartel of buyers.  First, though, let’s stop pretending like this is working like a market.  Second, don’t be fooled by the illusion that the current low oil prices will bring about serious structural changes anytime soon to undo the damage incurred since 2003.