The chief economist of BP – a former Bank of England governor who helped steer the UK through the global banking crisis – has now warned that shale has ‘thrown the gauntlet’ down to the conventional oil industry.
Spencer Dale (pictured) joined BP last year after 25 years at the Bank of England, including during the height of the global financial crisis.
Commenting on turbulence in crude oil prices in a recent speech on ‘the new economics of oil’, Dale said:
“I think the big message is that shale is changing things.
“US shale accounts for less than 5% of the market, so we should not think it is going to dominate everything -but it is enough when thinking about how markets respond to disturbances. It acts like a shock absorber.
“The second thing is that conventional oil is dominated by Big Oil companies with Big Balance Sheets that are not very sensitive to banking crises.
“US shale, though, is made up of 400-500 small producers, many of them with negative cash flow, so they have to keep borrowing to invest. What we observed in the financial crisis is that banking shocks amplify volatility. Up until now, the supply side of the oil market has been fairly insulated from that.
“Third, in the past, conventional oil has tended to mean big engineering projects, each one slightly different from the last – but shale is more like manufacturing.
“<With shale> You use the same rig, same location, drilling over and over and over again and in doing so, your costs come down, efficiency and productivity improves, and so shale has thrown down the gauntlet to conventional oil: Can you start doing greater standardisation?’
“Interestingly, US shale is far more price responsive because a producer can set themselves up and start drilling very quickly. Moreover, if the price falls it’s a lot easier to reduce production. Consequently, the supply features of the oil market are changing and over the next 20-30 years, price volatility might fall as a result.
“This contrasts with the past in which volatility in prices was a feature of a market in which both demand and supply were relatively insensitive to price, because you need to put petrol in your car every day and it is not easy for the conventional industry to simply turn off the taps.”
On crude oil prices, Dale cites evidence which suggests that any recovery from the present crude crisis may not be a swift as in the past because of different underlying causes.
He explained: ”If you consider the two most recent big drops – 2008-2009 and 1998 – both of those were driven by economic recessions, the global recession in 2008 and the Asian crisis in 1998. So, we saw big falls in demand. Those tend to correct themselves relatively quickly.
“In contrast, the present price weakness was caused by strong growth in supply, initially as a result of very strong growth in US shale. Normally, world demand for oil grows by about 0.8 million barrels a day per year, but at the end of last year US shale, on its own, grew by 1.6 million barrels a day. Last year, we saw a combination of supply increments from Iraq and Saudi Arabia that added a further 1.5 million barrels a day.
“What we know from history is that the oil market takes an awful lot longer to adjust to supply shocks than it does to cyclical demand shocks.”
Benchmark Brent crude gained 5% to close at $34.37 a barrel last night as Russia opened a shaft of sunlight in the over-supply gloom by saying it was willing to talk with OPEC about cutting oil output.