How Low Will Oil Go?
How Low Will Oil Go?

As prices at the pump continue to fall, oil producing nations (the United States among them) face a host of new challenges in a rapidly changing global energy picture

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20 Jan 2015   Christian Camerota

The last six years have proved just how fluid the international oil market is. And if recent support of the Keystone Pipeline by the U.S. House of Representatives and the Nebraska Supreme Court (which approved the pipeline’s path through that state) are any indication, change will be the constant in the near future as well.

Gasoline and oil are at their lowest prices since 2008, a year that saw oil peak at record highs of $140 a barrel before plummeting to just below $50 by year’s end, roughly where it stands again today. Those prices are largely dictated by the Organization of the Petroleum Exporting Countries’ (OPEC) so-called spare production capacity– that is, the amount of production OPEC (which accounts for 60 percent of petroleum traded internationally) can bring online within 30 days and sustain for at least 90. Spare capacity is robust at present thanks to factors like a slow-paced world economy, curtailed oil demand due to conservation efforts and concern about greenhouse gas emissions, and the fact that many countries have upped their domestic production and thus reduced their imports. One of the most notable new producers is the United States, which has seen a boom in oil and natural gas production thanks to hydraulic fracturing (fracking) applied to abundant supplies of shale.

Harvard Business School professor Dick Vietor, the School’s Paul Whiton Cherington Professor of Business Administration, teaches courses on the international political economy and has published dozens of cases on energy policy. Of late, he’s taken a keen interest in how the shifting energy market is influencing geopolitics, particularly as the shale revolution turns the U.S. into a hotbed of domestic and foreign energy investment and reshapes the global energy picture. In this new world, OPEC members have openly refused to reduce their production levels to stabilize and bolster oil prices, largely because most of their governmental budgets rely heavily or entirely on oil revenues.

"LOOKING AT THE BIG PICTURE IN THE CURRENT ENERGY ENVIRONMENT, I THINK OPEC'S ROLE AS MANAGER OF THE WORLD'S OIL SUPPLY HAS JUST ABOUT RUN ITS COURSE"

“Many OPEC members, like Iran, Iraq, and Venezuela, are running budget deficits, even with oil revenues,” Vietor said in a recent interview in his Morgan Hall office. “If their revenues drop, whether from limited production or falling oil prices, they’re going to have big problems with their governments. In some cases, it could even cause a revolution. And we’re reaching that point right now, where there’s simply too much oil and not enough demand.”

Saudi Arabia is the anomaly among OPEC producers. It accounts for about 70 percent of spare production capacity, according to the International Energy Administration, and therefore has much more budgetary freedom with which to manipulate the world oil market. Vietor believes that after having been rebuffed by other OPEC producers recently in pushing for production limits, Saudi Arabia is now content to stand pat and let the market fix itself.

“Oil is a large part of the Saudis’ budget as well, but they’re also running a huge surplus,” he said. “So I think they’ve decided they can take the lower prices better than anyone else. Their costs are perhaps between $10 and $15 a barrel. They can let prices fall and although they may go into deficit, everyone else [other OPEC members] will just about go out of business. Then prices will probably stabilize at $80 or $90 a barrel in a few years. Looking at the big picture in the current energy environment, I think OPEC’s role as manager of the world’s oil supply has just about run its course.”

"IF THE PRICE OF OIL IS HIGH ENOUGH, SOMEONE WILL SOLVE THE COMPLEXITIES OF HORIZONTAL DRILLING AND FRACKING. BUT WITH THOSE SOLUTIONS...COME SOME MAJOR CONCERNS"

One reason OPEC’s hold on the world oil market has loosened is that the U.S. has quadrupled its oil production over the last six years thanks to fracking, a complex technique that combines both vertical and horizontal drilling and uses highly-pressurized water jets to force fossil fuels like oil and natural gas up from otherwise-unreachable rock beds. This new technology has enabled U.S. companies to access some of the estimated 36 billion barrels of “proved oil reserves” in this country, a number that has increased five years in a row.

“What we found out during the last six years is that if the price of oil is high enough, someone will solve the complexities of horizontal drilling and fracking,” Vietor said. “But with those solutions, and now the ensuing falling prices for oil, come some major concerns. Environmentalists, for instance, are not happy, since just as they’re beginning to see a decline in demand and have the support of a president who’s determined to stop climate change, if oil prices are down, everybody will start buying gigantic vehicles again, and carbon emissions will go right back up.”

The precipitous decline of oil prices also threatens the long-term viability of some of the country’s shale oil projects. Shale oil is expensive to harvest and becomes prohibitively so as oil prices fall. And this is to say nothing of emerging concerns about both the relatively short lifespan of shale wells (production, for example, has declined in wells in the Bakken fields in North Dakota by 85 percent in just three years, compared to 20-year terms in more traditional wells) and the environmental dangers inherent in the process: related earthquakes, exorbitant water needs, and the release of methane gas, to name a few.

The Keystone Pipeline could further bolster U.S. oil production, moving a million barrels of tar sands oil each day from western Canada to the refineries along the Gulf coast. The project has been stalled in legal and political battles for eight years and still faces the likelihood of a presidential veto if approved by the Republican-dominated U.S. Senate. But, domestic politics aside, according to Vietor, the administration may not be able to ignore the project’s potential for job creation and positive influence on U.S.-Canada relations.

“Every Republican and most Democrats in the Midwest want to approve Keystone,” Vietor said. “It will create 7,000 temporary jobs, 400 permanent jobs, and 2,000 related jobs as well as provide a million barrels of oil every day to refiners that need it. With all the economic issues on the one hand and environmental worries on the other, I must confess I don’t know what President Obama is going to do.”

Meanwhile, consumers will continue to enjoy paying much less at the gas pump. Unfortunately, Vietor added, low oil prices won’t lower the costs of other goods or services significantly. “Oil prices mostly affect transportation,” he said, “so low prices don’t work their way through the system as much.”

So what would it take to drive up the price of oil again?

“The quickest thing would be an OPEC agreement to cut production by 3 or 4 million barrels,” Vietor concluded. “Beyond that, any political unrest in OPEC countries or even conflicts between them could cause prices to spike. Despite a lot of new production methods, the reality is that the world consumes more than 80 million barrels of oil per day. So if that spare capacity gets low suddenly, prices could go right back up. It doesn’t take much.”

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