Professor Lutz Mez: "Prices for oil will rise, the peak of the American "shale bubble" is over

By Tageszeitung

The long-term drop in oil prices is one of the main factors affecting the economies of Russia, Kazakhstan and Azerbaijan. The price is below $50 per barrel. Professor Lutz Mez, a German energy expert, a member of the Free University of Berlin, the founder of BC CARE, has shared his outlook on the situation.

- Mr. Mez, we are undergoing a dramatic fall in oil prices, it has more than halved in the last few months. What is the reason?

- There is probably a whole bundle of reasons. First of all, I would note investors who have been investing enormous funds in raw material and energy markets for many years. In recent months, they have marked their withdrawal from the oil market, a product remaining the number one energy carrier in the world. The scale of speculations is very big too. We need to understand: the volume of speculated oil trade exceeded the volume of real consumed oil three-fold before. Now, oil speculation exceeds the real volumes of its consumption 12 times more.

- So, speculation on the market is a significant reason for the crash of the oil price? Critics of this thesis say that it is impossible to prove the empirical impact of speculation on the oil price...

- And again, there are several reasons conditioning the process that is seen. Oil speculation intensified greatly later, and it certainly affects the price. Now a barrel of oil is sold 12 times before being used or stockpiled as a reserve. The scale of reserving oil is another factor of the falling price - it has increased significantly too. The U.S. has oil reserves for over two years. They are the buffer for a possible deficit conditioned by the crisis or natural catastrophes such as Hurricane Katrina. And when the reservoirs are filled with oil, it lowers the price for it too.

- Why did the price crash start in June 2014?

- There was no actual "trigger." Speculators started investing in other markets and putting bets on a fall in the price on the oil market. Such a substitution of  market trends may develop gradually. The easing of tensions around Iran marked in the summer probably played its role. Besides, since the end of May 2014, Kurds and the Islamic State have been selling oil. The role of these factors cannot be overestimated, but they are little pieces of a general mosaic.

- What conditions the harsh dynamic: prices halved in just a few months?

- Because the price had been raised artificially, due to speculations again. The consistent price fall was strengthened by the gregarious instinct of speculators. Let's keep in mind that the oil market is not rational and does not follow the classic laws of the market. It is dominated by the modified value law: prices for a product may be determined by manufacturing prices because no single supplier can satiate the market alone.

- How do demand and supply determine the price? In the U.S., we keep seeing a slight excess of supply because of shale oil extraction. Americans are now producing about two million more barrels of oil a day than the previous year.

- According to a BP statistical analysis, the U.S. and its daily production of 10 million barrels of oil a day is ranked third in the world in terms of oil extraction. The significant increase in extraction of untraditional oil in the U.S. and Canada, shale oil that is, development of deep-water oil and oil sands is certainly another reason for the global fall in the oil price. The U.S. need for oil imports has halved.

- Meanwhile, Japan is in recession, many countries of the EU have economic ordeals, the rate of economic growth of China is falling. Italy has reduced oil consumption by 35% in the last 10 years...

- The level of energy consumption of the Organization of Economic Cooperation and Development is generally in stagnation and partly even falling. It is one of the reasons for reduction of the oil price. And the two largest oil-extracting countries, Russia and Saudi Arabia, are not even planning to reduce the volume of extraction.

- Why?

- Why should they? At an actual price for oil of a little less than $50 per barrel, at least, the Saudis, Russians and Iranians are still in the green and can make profit from its sales, while competitors extracting more expensive oil waste their money. Expensive "high technology" oil is partly displaced from the market.

- With ever-increasing frequency, there are talks about an oil war against the U.S. Saudi Arabia is said to be repudiating stabilization efforts on purpose to displace American shale oil.

- Saudi Arabia undeniably takes thr hardships of its competitors into account as a pleasant side effect.

- What are firms and extracting companies that cannot make profit from oil doing at the moment? An oil platform in the ocean cannot be turned off just because the price of oil is making a dramatic fall...

- The UK is temporarily deactivating sea-based oil platforms. Small extractors in Australia and the U.S. are forced to declare bankruptcy.

- Then supply will fall again and the ball of cheap oil will end?

- That is how it will be.

- How much lower can the price of oil fall?

- Now, in early January, we see the price below $50. According to my assessment, it will not fall any lower.

- Russia alone lost $100 billion in 2014 because of the cheap oil price and the ruble crash.

- Saudi Arabia, Russia and even Iran have serious currency reserves and big funds created from oil money. The reserve in Russia, for example, exceeds $450 billion. They can take low oil prices for some more time. And, of course, everyone knows that it will rise again. Other countries, such as Libya, Venezuela and Nigeria, face even more serious problems. It is a tragedy of riches: those who have an abundance of natural resources and who depend on them get into trouble in hard times.

- Low oil prices should stimulate demand and increase consumption. How flexible is the public reaction to the price crash?

- I do not drive a car more often because gasoline became cheaper. I do not burn more heating oil just because its price became lower. In terms of demand, hence, there is no real animation. Oil consumption in many countries depends on temperature conditions to a great extent. A very cold winter, for example, would have inflated oil consumption. Another, clear tendency can be seen in transportation: motors become more economical, the driving style changes, cars with diesel engines are purchased more often. Reduction of oil consumption in the transportation sector in Germany has been seen for about a decade.

- The low price of oil conditioned freezing of costly oil projects until better times. What will happen if the American "shale bubble" pops and extraction of shale oil will have dropped by the end of the decade? Would the world oil supply drop equally fast that it would cause catastrophic consequences?

- The bubble of U.S. shale oil has already reached its peak. Investors went through it three years ago. The growth rate in the sector dropped greatly. The main problems of untraditional fields are the complexity of finding them, they are relatively small, rich fields have actually already been developed. Thus, it is already clear that oil extraction in the U.S. will drop in a few years. Nonetheless, I do not believe in catastrophic scenarios. We must not forget about the switch to alternative energy sources. Unfortunately, when we talk about them, we always see only the electricity sector. But 80% of final energy consumed in Germany is not electricity, and it is covered primarily by non-renewable sources: oil, gas, coal. We need to replace them with renewable sources and efficient energy consumption. One thing is clear: we need to finally give up on oil. Renewable energy should finally be used on the heating market more actively. It is a big task for us indeed. Germany is far from being an example in this aspect. Sweden, Austria and Finland are far ahead of us. The conservative government of Sweden made provisions in 2009 that oil consumption should be lowered from the current 30% to zero by 2020, when opening new energy demands of the country. It is an ambitious plan.

- How successful have the Swedes been in implementing it so far?

- Sweden is on the right track. In 2012, oil was used to produce only 25% of the energy in the country.

- Sweden is not the only [country] where more oil is replaced by gas on the heating market. How big was the impact of the low gas price on the oil price?

- It is another indicator. The price of gas in 2014 more than halved and became exceptionally low, especially in the ratio to oil. Iran wants to start putting gas into oil fields to increase oil extraction. Norway is putting its bets on this strategy too. Of course, it takes geological prerequisites.

- What is your forecast for the oil price in mid-2015?

- If I knew the answer to that question, I would have been a renowned market guru.

- But what does intuition tell you?

- Intuition says: at least $80. It is the limit for the high-technology oil produced.