The long-term effects will echo for a decade or more. By Larry Kummer, Editor of the Fabius Maximus website
Oil prices fell by over half from June 2014 to January 2015 (Brent: $110 to $50), then another one-third since (to $35). Natural gas and coal prices have also plunged, partially due to the same forces but also from substitution.
These are the results from a modest slowing of demand growth and — more importantly — the decision of the Saudi Princes to wage the first financial war against next-gen oil producers, those that tap oil sands, shale fields, and deep ocean deposits.
This is how Bloomberg put it:
Saudi Arabia won’t be satisfied with another temporary rebound in oil prices, such as the one that occurred last spring: Their U.S. competitors would just increase output again. They must inflict permanent damage by demonstrating to investors that with shale, they can’t bet on any kind of predictable return.
This will not end quickly; the list of casualties will be long. Goldman found $1 trillion in “stranded” or “zombie” investments in oil fields — a year ago at $70 oil. At $35 oil the total would be much larger.
The end will come with the bankruptcy or restructuring of many next-gen oil corporations, followed by a newly empowered (and perhaps expanded) OPEC cutting production to bring spare capacity back to average (3 or 4 million b/day) — providing a valuable production cushion for the world economy’s supply of this vital input. The long-term effects will echo for a decade or more: a higher cost of capital for and depressed risk-taking in the petroleum and coal industries.
The bond market has already begun to price in the coming bankruptcies of oil and natural gas Exploration and Production companies. But the geopolitical implications remain largely unexplored.
The global effects
As a first cut, the aggregate global gains and losses from lower energy prices sum to zero. The full effect depends on the balance between the small gains in the majority of regions that import energy — and the potentially catastrophic effect on those that produce it.
This short period of lower prices provides an opportunity for energy importers (including the US) to prepare for the higher prices to come. Foolish nations sell into low prices, such as America’s sales from strategic oil reserve at generational low prices (as Clinton did in 1997). Smart nations increase their energy efficiency and, even more importantly, cut energy subsidies (listed in the New York Times and Financial Times).
Malaysia led the way with reforms whose effects will continue long after oil prices recover. The IMF:
After raising electricity tariffs in early 2014, [the Malaysian government] took advantage of lower energy prices in the second half of 2014 to reduce and ultimately remove remaining gasoline and diesel subsidies. … [Subsidy reform should]…