This article first appeared in The Edge Malaysia Weekly on January 13, 2020 - January 19, 2020
THE muted and short-term reaction in the crude oil market on the escalation of conflict between the US and Iran signals the end of petroleum diplomacy between the oil states, especially those in the Middle East.
The current situation is markedly different from that in the 1970s and 1980s, when crises in the Middle East triggered oil shocks, jeopardising the health of the world’s economy. In fact, the Iranian revolution in 1979 and the subsequent Gulf War in 1980 sent the US economy into recession.
“It is a different world altogether now compared with that of 1979. The US depends less on crude oil from the Organization of the Petroleum Exporting Countries (Opec) countries nowadays, and the fact that it took actions that can be deemed as reckless shows the end of this dependency,” says Dr Renato Lima de Oliveira, assistant professor at the Asia School of Business.
The benchmark Brent crude jumped 0.45% on Jan 3 to US$68.91 per barrel after Iran’s top military commander, General Qasem Soleimani, was killed in a US drone attack while he was in Iraq.
Following the attack and subsequent show of force by Iran on Jan 8, Brent crude resettled to US$65.25 per barrel. Oil and gas (O&G) industry experts are still keeping their crude oil price targets this year, with one saying it would average US$60 per barrel.
What happened? The experts say the world is no longer beholden to the petroleum powers in the Middle East, thanks to technological development in the O&G industry, as well as the transport sector.
Net imports of crude oil and petroleum products by the US totalled 5.65 million barrels per day in January 1973. It grew to a peak of 13.4 million bpd in October 2005, but has since tapered off. The US turned into a net exporter of oil for the first time in September 2019.
Technological development in the O&G industry has resulted in the exploitation of shale gas in the US, unlocking vast amounts of untapped resources. The country’s shale production increased from 1.3 trillion cu ft in 2007 to 22 trillion cu ft in 2018, according to data by the US Energy Information Administration (EIA).
Not only is the US no longer dependent on crude petroleum from the Middle East to fuel its economy, but sources of crude oil have also become more diversified now compared with in the 1970s.
In 1973, North America produced 23.2% of the 58.5 million barrels produced globally daily, while the Middle East’s share of the world’s crude oil production was 36.3%. Europe, excluding the USSR, produced only 880,000 bpd, or a miniscule 1.5% of the world’s production in 1973.
By 2018, however, while North America’s share of the world’s crude oil production was still around the same level, the share of Middle East crude had fallen to 33.5%. Meanwhile, Europe has taken up market share over the years, producing 3.7% of the world’s crude oil in 2018.
US oil production was the lowest in 2008, when it produced only 6.78 million bpd, for a market share of 8.2% of the world’s total. Since then, US oil production has increased by 8.53 million bpd, to 15.3 million bpd in 2018, accounting for a market share of 16.2%.
During the decade of 2008 to 2018, the US added production equivalent to the entire crude oil production of the African continent in 2018, doubling its share of global production. Meanwhile, the Middle East added 5.3 million bpd in that period.
By 2008, the US was the third-largest producer of crude oil in the world, behind Saudi Arabia and Russia. In 2014, however, it overtook both countries in terms of crude oil production, and managed to stay in the top position for four of the five years to 2018.
Electric vehicles to reducedependency on crude oil
Besides technology-driven crude oil production in the US and diversification of global sources, the expectation that electric vehicles (EVs) will become more common in the streets in the years ahead also points to lower global dependency on crude oil.
The global EV fleet is projected to reach 130 million units by 2030, according to the International Energy Agency’s (IEA) Stated Policies Scenario. The growth in EV sales will be led by China, which is expected to add 19 million battery-fuelled vehicles this decade.
Today, China already has the world’s largest fleet of EVs, making up 45% of the world’s stock in 2018, with 2.3 million cars, ahead of Europe with 1.24 million cars and the US with 1.12 million cars.
“The growth of EVs is going to be more prominent in the years ahead. With oil products used mostly for transport at the moment, the proliferation of EVs will affect demand for the fuel,” says de Oliveira.
The usage of oil and oil products globally for power generation has fallen to 3.8% in 2017, from 11.5% in 1973, as countries make the shift towards cleaner and cheaper fuel for electricity generation.
On the other hand, the transport sector’s share of the usage of oil products has increased to 43.88% in 2017, from 31.63% in 1973, as the growing economy in China, India and many emerging market countries led to a boom in private vehicle ownership in these countries.
IEA projects, however, that between 2019 and 2040, the transport sector will consume 276 million tonnes of oil equivalent per day less energy, based on the Sustainable Development Scenario.
The world also requires less energy to generate economic activity now, as the digital and technology-driven industries and services industries came to the fore in the global economy. According to IEA, in 1990 the world required 178.66kg of oil equivalent to generate US$1,000 of gross domestic product. This has decreased to 126.43kg of oil equivalent in 2014.
The muted impact on crude oil prices after the killing of Soleimani and the attack on US bases in Iraq by Iran early last week shows that the fundamentals of the global economy still trump geopolitical crisis in the Middle East.
This is especially so when the US and Iran do not seem to want to escalate the crisis further, with US President Donald Trump downplaying the attacks.
In a Jan 9 note, Hussein Sayed, chief market strategist at FXTM, says: “The nightmare scenario of a full-blown war looks to be over and investors can finally breathe a sigh of relief. Yet, even if a conflict has been averted, the road ahead remains bumpy and investors should remain on standby for further possible retaliatory measures.
“However, fundamentals are quickly returning to the fore after being dominated by geopolitical factors [last] week.”
Hussein adds that most of the geopolitical risk premium has been erased. The oil market will see further downward pressure if inventories build up in the weeks to come.
“While prices have returned close to their fair value, traders will need to closely monitor the situation in Iraq and whether any activity by proxy militias will lead to supply disruption. Otherwise, prices are likely to remain capped at US$70 in the near term,” he notes.
What does it mean for Malaysia?
The stable crude oil price should be beneficial for Malaysia, as the country is still trying to recalibrate its fuel subsidy programme and government finances. While Malaysia produces and exports oil and oil products, it also subsidises oil products — which means less benefit to the coffers if oil prices keep rising.
An estimate by the Ministry of Finance in 2018 points out that every US$1 increase in oil price could add about US$300 million to the national budget. That is a linear prediction, however, which assumes everything else is constant.
“Also, higher oil prices mean more subsidies to keep prices at the pump affordable and higher energy costs that the industry might need to shift to consumers,” says de Oliveira.
He adds that if the crisis in the Middle East were to end up in a conflict and have a greater impact on oil prices, other economic activities will be negatively affected as well, reducing the tax base and job creation in the non-oil sector of the economy.
Instead of praying for higher crude oil prices to boost the national coffers, Malaysia should develop more of its natural gas fields, as demand for natural gas is expected to steadily continue in the future as more countries switch to the cleaner fossil fuel rather than coal for electricity generation, says de Oliveira.
Malaysia produced 71 million tonnes of oil equivalent of natural gas per day in 2017, or about 480,000 barrels of oil equivalent per day, according to data by the Energy Commission. Most of the Malaysian gas is exported to Japan and South Korea in long-term contracts.
In the Global Gas and LNG Outlook 2035 report by McKinsey & Co released last September, gas is forecast to become the fastest-growing fossil fuel until 2035, growing at an average of 0.9% per year.
The research firm states that power generation and industrial sectors in Asia and North America, as well as the residential and commercial sectors in Southeast Asia, along with China, will drive the expected growth in demand for gas.
“Strong growth from these regions will more than offset demand declines from the mature gas markets of Europe and Northeast Asia. Gas supply to meet this demand will come mainly from Africa, China, Russia and the shale gas-rich US,” the research firm points out.
At the same time, liquefied natural gas (LNG) demand is expected to outpace the overall growth of gas demand, growing at 3.6% per year until 2035, notes McKinsey, as Asian markets rely more on distant supplies and Europe’s dependence on imported gas increases.
“China will be a major driver of LNG demand growth, as its domestic supply and pipeline flows will be insufficient to meet rising demand. Similarly, Bangladesh, Pakistan and South Asia will rely on LNG to meet growing demand to replace declining domestic supplies. We also expect Europe to increase LNG imports to help offset declining domestic supply.
“Demand growth by the middle of the next decade should balance the excess LNG capacity in the current market and planned capacity additions. We expect that further capacity growth of around 250 billion cu m will be necessary to meet demand [till] 2035,” says McKinsey.
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