By John Richardson
Our three scenarios for oil prices, in our study, Demand: The New Direction for Profit, includes one scenario where oil prices in today’s money fall to a long-term average of around $25/bbl. Here are all three scenarios.
- $25/bbl oil = Collapsing demand.
- $50/bbl oil = Comfortable middle.
- 100/bbl oil = Continuing tension
$25/bbl has long been my base-case scenario. I believe that this scenario is even more likely following Mr Trump’s success in the US presidential election.
We know that at the very heart of Mr Trump’s campaign was jobs – both the quantity and quality of jobs. He very skilfully tapped into in to all the anger, resentment and sadness, particularly in those critical swing states, over diminished economic opportunities.
Despite all the optimistic commentary from mainstream politicians about the number of jobs created since the Global Financial Crisis (GFC), it didn’t feel like this on the ground – in many blue collar, or working class, communities.
Both working and middle class incomes in America have stagnated for many, many years – and now face even more downward pressure because of the retirement of the Babyboomers. Sure, jobs have indeed been created in high numbers since the end of the GFC, but flipping burgers in a fast-food restaurant doesn’t replace the earnings or the status of working in a steel mill.
And as I have been pointing out for several years now, one of the few genuine bright spots in the US economy is shale oil and shale gas. This is the innovative, entrepreneurial nature of America is at its best. Costs have been constantly driven down, productivity increased and debt restructured to the point where what it already costs to make a barrel of oil in the US is way below what most analysts had thought would ever be possible.
Drill, drill and drill some more
Oil and gas production equals lots of jobs, and many good jobs as well – in say welding pipes. The president-elect seems to understand this, hence his plan to reduce taxes for energy companies, open federal lands for drilling, and remove many of the regulations restricting exploration that have been introduced since 2009.
When you look at what has already been achieved in terms of lowering production costs and increasing oil output, just imagine what could happen now. Backed with tax breaks and less regulation, the US energy industry will go hell-for-leather in driving output higher and oil prices low.
The benefit to local economies, such as the Dakotas and Texas, will be huge. Lots more good jobs will be created, leading to possibly even more federal and state-level support.
The US oil industry will thus drill, drill and drill and pursue a market share strategy, and in so doing will follow in the footsteps of OPEC.
I believe that OPEC has already given up on the hope of controlling oil prices because we are at, or very close to, peak demand growth for crude. The priority at OPEC – and non-OPEC producers such as Russia – is to pump, pump and pump whilst they can. They cannot afford the risk being forced to leave their most-valuable national asset in the ground.
Why have oil producers reached this conclusion?
Why buy a car when you have Facebook?
One reason is the retirement of the Babyboomers. When you come round to retirement, you have already bought most of the things you need, such as your home – and of course houses are made from lots of things that are made from oil – i.e. chemicals and polymers. You are also driving less because you are obviously not going to work anymore. Nor are you taking the kids to and from school and soccer practice.
I also believe that changing demographics is changing society’s attitudes. Older people tend to be more cautious and conservative.
Next come the young people. They are both living in more straitened times and accept that the environmental debate is over. The views of the scientific consensus on climate change will increasingly be reinforced by likeminded groups on social media that are mainly formed and followed by young people. And when you can keep in touch with your friends via Facebook, why even own a car?
The cost of renewables has also collapsed. Even without subsidies, wind and solar have become exceptionally cost-effective forms of electricity generation.
This is not just about global warming. It is also about air quality and human health. In countries such as China, where 1.6m people die every year from air pollution, there is a tremendous motivation to improve say the fuel-efficiency of automobiles and rapidly develop local electric car technologies.
The US federal government may well move in the opposite direction on climate change following Mr Trump’s promise to pull out of the COP21 agreement.
But the momentum in other countries will remain the same, for all the reasons above. And some US states, of course remain under Democratic control, including most notably California. If California were a country in its own right, it would be the sixth-biggest in the world.
Next comes the effect of Mr Trump’s likely economic policies on the global economy. His tax cuts and infrastructure spending would drive the dollar higher as US inflation increased. A global trade war, with major negative implications for export-dependent emerging market economies, would also encourage a flight to the dollar. When the dollar strengthens, oil prices fall.
There is also a significant risk that a global trade war will cause a global recession, driving-down the demand for crude.
Impact on petrochemicals prices
We need to model what this means for petrochemicals markets. See below our base case for oil, naphtha and China injection-grade high-density polyethylene (HDPE) prices from November 2016 until October 2017:
- We assume that oil prices will average $48/bbl and so naphtha prices will average $440/tonne (naphtha per tonne was calculated at 8-9 times the price per barrel of oil, as is the historic norm).
- We next assume the “spread”, or gap, between the cost of naphtha and the price of HDPE at an average of $649/tonne. This is line with the actual January 2015-Oct 2016 average spread $646/tonne. HDPE producers have enjoyed strong pricing power since the collapse of oil prices in September 2014.
- This results in an average HDPE price of $1,090/tonne.
See below my perhaps extreme downside scenario:
- Brent falls to an average of $29.50, and with it naphtha to $271/tonne.
- The average HDPE spread is at $488/tonne, back to slightly above the average 2000-2014 spread of $465/tonne.
- The average HDPE price is $757/tonne.
As I said, this could be an extreme scenario, especially up until Mr Trump’s inauguration on 20 January. But As Andrew Rawnsley wrote in yesterday’s Observer newspaper:
By all means hope for the best. It will make it easier to sleep at night. The sensible will prepare for the worst.
What could all of this mean for petrochemicals demand growth, for the relative competitiveness of producers and for margins or profitability over the next 12 months? Crucially also, what would this mean for the wider global economy? Are we really facing a recession in 2017, perhaps even something akin to the Great Depression?
These are the subjects of my post on Wednesday.