Stability in the oil market remains elusive

The past few weeks have witnessed remarkable instability in the oil market and a desperate international effort to remedy the situation. The deal reached last weekend between OPEC, Russia and other oil producers has not succeeded in lifting prices. That agreement, headlined as a cut of 10m barrels a day in production, includes all the previous cuts made since October 2018 which have been counted in to make the total sound larger. The actual additional reduction painfully agreed was less than 3m barrels a day.

A very modest reduction of this sort is clearly completely inadequate in the face of a fall in year-on-year demand in April of 29m barrels per day, followed by falls of 26mbd in May and 15mbd in June. These are the estimates produced by the International Energy Agency in its latest oil market report published on 15^th April. Beyond mid-year, the IEA’s projection is for some recovery of the global economy, leading to a net fall in oil demand over the year as a whole of around 9mbd. There are many uncertainties around this of course and the numbers should be taken as indicative rather than precise.

Last weekend’s meeting, held under the auspices of the G20, did not stabilise prices but was significant for a number of other reasons.

First, it confirmed that OPEC has lost its power in the energy market. Cuts at this scale are biting into the basic revenue requirements of member states. Few of the OPEC member states can cut any further without inflicting real self harm. Nor can the Russians. Putin needs, as he has for the last 20 years, a steady flow of revenue to maintain his power in Russia. Oil is in chronic structural oversupply and for the first time in more than half a century the market is no longer controlled by producer power.

Secondly, the failure of the deal confirmed that the crucial roles in the energy market have passed to the United States—whose emergence, thanks to oil from shale rocks, as an oil exporter has disrupted previous certainties—and to China, whose increasing demand for oil imports has absorbed most of the volumes of global production added over the last decade. Between them, the US and China now shape the oil market and everyone else is a price taker. What happens next will depend on whether the companies behind the US shale revolution now decide that at $30 a barrel or less it is better to shut production and whether the Chinese government decides that reviving the economy is now the imperative element of policy.

The outcome should become clear over the next month. Until then the price will remain low. Longer term as a new balance is found prices should rise with renewed economic growth, but are unlikely to return to pre-crisis levels because of the weight of potential supply ready to come onto the market at the first sign of any increase in demand.

Beyond these market-specific matters two further elements of significance arise from last weekend’s meeting. The first is the emergence of the IEA, whose Executive Director Fatih Birol initiated the dialogue, as a key player in the process of stabilisation. The IEA has skilfully moved from being the protector of consumer interests—it’s original role when the agency was established after the 1973 oil crisis—to being a key international institution bringing together all the participants, producers and consumers alike in pursuit of the stability which is crucial for sustainable energy security. The agency is well placed to manage the next phase of the stabilisation process and also to take the lead in overseeing the even greater unresolved challenge of matching energy needs to the imperatives of decarbonisation in the fight against climate change.

The next element of significance is the development over recent months of the G20—which for the first time since the financial crisis of 2008 has established itself at the heart of key global issues including the response to the Covid-19 epidemic as well as the disruption in the oil market. One of the few positive side effects of the dramatic and destructive events of the last few months is the emergence of a new set of international institutional structures. The inquest into how Covid-19 was handled which will follow the pandemic could throw up even more—not least in the areas of global health. The new institutions are replacing the Atlantic-based models created at Bretton Woods 75 years ago and putting in their place structures inclusive of the new world powers, such as China and India, and agendas which match the challenges of the time. 2020 will be seen as a dark year—a year of plague, recession and unemployment. But it could also be remembered as the year when the era of globalisation began to build the bodies of governance which have been so absent for too long.