Originally posted on ABCtech QuikTech Notes, Aug 28, 2015

Is oil price predictable?

By Robert Lam Date: 28 August 2015   β Follow Me

Victor Habbick Oil Drum

Oil Drum With Pipes Image courtesy of [Victor Habbick] at FreeDigitalPhotos.net

Published on 03 September 2012 Stock photo – Image ID: 100100680

Oil prices plunged further in trading to below $39 per barrel, the low for the first time not seen since the global financial meltdown some six years ago. This dramatic oil price slide trend started in 2014, from the high of over $100 per barrel as recent as June 2014.

Bank of Canada has been providing economic updates on the current affairs of the Canadian economy. “The rapid fall in oil prices will have both positive and negative effects on different sectors of the Canadian economy,” said Rhys Mendes, an economist at the Bank of Canada.

On a positive note; anticipated economic growth in U.S. and a weaker Canadian dollar have boosted non-energy Canadian exports. Lower oil prices and other commodities will also lower input cost; thus reducing the production cost of many things. The impacts will be positive for manufacturing sectors, lower prices for consumers and translating to higher disposable incomes in general.

The negative consequence of the oil-price downward shift will be felt across the country – in the long term; it is observed that nearly 30% of supply chain supporting the Alberta oil industry comes from other provinces across the country. As the lower oil prices persist, it will significantly slow down or even stop new investments in exploration and development projects in the oil industry. A prolong lower oil price will be especially bad for the Canadian and Alberta economy specifically, the average production cost from oilsand is $50 plus per barrel. And, the lack of new investments also means less or no demand on goods and services across the supply chain, which supports the Alberta oil industry, resulting in overall lower job growth and incomes in general across multiple regions.

The logical question is whether we can predict oil prices, and formulate mitigation strategy.

The recent dramatic slides of the oil prices about a year ago were not entirely random. Though we do not have a crystal ball, but predicting is part art and part science – it is all about understanding and distilling signal and noise. And, what we can do is to creating multiple lenses parallel some of the key forces at play (Economic, Political, Technology, Environmental), and help to uncover and magnify the underlying signposts.

Economic lenses:

World oil production has been growing steadily; United States has seen a booming growth in shale oil production, thanks to the advancement in horizontal drilling technology which allows access to hydrocarbons deep beneath the Earth’s surface. Canada and Russia also experience increasing its oil production.

While demand for oil in many regions including Japan and Europe are decreasing due to slower economic activity, China is actively signalling to the world since in 2013 that it would deliberately slow its previously exceptional rate of economic growth. And Beijing has done so, in order to put a lid on spiralling debt and to head off an inflation spectre. Another of China’s major trading partner, Japan, is still trying to recover from a 24-year-long economic malaise.

In sum, the oil supply simply is greater than there is demand, and is having a predictable effect on downward prices slide.

Political lenses:

The Organization of the Petroleum Exporting Countries (OPEC) – a group of significant oil producing nations including Saudi Arabia and Iran that holds tremendous supplier power; exporting 40% of global oil supply. OPEC has consistently deciding not to adjust the output quota to meet the decreasing demand, resulted in the over-supply on oil in the market driving the oil prices continuing the dramatic slide.

Technology lenses:

Conventional wisdom might suggest that the collapse in the price of oil must be dealing a potentially fatal blow to renewable power. And, US EIA said that low oil prices won’t hurt renewable energy. Tax incentives more important than oil price and oil is not in head-on competition with renewables for electricity production, says U.S government’s chief energy analyst.

There are rapid and frequent technological advancements in wind turbines and solar panels manufacturing. The dramatic cost reduction in manufacturing in the last decade allows the industry to continue to invest in R&D and further improve mass production cost.

Environmental lenses:

At the end of the year, a summit on climate change in Paris – This is where 190 countries will meet to negotiate a deal on cutting greenhouse gases. So, will the low oil price be a contributing factor?

Call to Actions:

Can we predict oil prices? The forces that have led to the recent decline in prices – economic 101; supply greater than demand seem to hold true. However, that is one difference from those that led to previous declines. This time, it is likely that low prices will persist for a prolonged period of time – based on the above mentioned forces. All key stakeholders; major producers and consumers, and policy makers (government) will have to re-calibrate their strategies and economic policies to align to these disruptive changes in the global energy landscape.

Different markets

Let’s observe this fact; oil does not compete with renewable energy directly. They target different segment of the market – oil is to transportation while renewables generate electricity. So the oil price does not directly affect the market that renewables are operating in.

Consuming countries employ a portfolio approach and diversify their energy mix – reduce the share of carbon fuels and increase the share of renewable energy (wind, solar, biofuel, etc.). It is an attempt to mitigate the risks of stable energy supply and climate change. The International Energy Agency (IEA) forecast that by 2035; wind and solar will account for 45% of new power generation expansion.

Making a deal

At the end of the year, there is a summit on climate change in Paris – This is where 190 countries will meet to cut a deal on reducing greenhouse gases. Will the low oil price be a deciding factor?

Taking the holistic view

The long-term trend is clear. The rapid and frequent technological advancements in renewable energy pushing the manufacturing cost down, and in particular solar power generated electricity, and ways of storing it, are getting ever cheaper and better. It is renewable source and sustainable development, it also contribute to reducing greenhouse emission, and help to manage global warming trend.

In addition, lower oil prices help boost growth in consuming countries in the coming months. European governments especially might feel confidence enough financially to take further action on climate change policy.

And future government policies should take this opportunity to support renewables – to help diversify the economy and to build a better future – economically and environmentally.

 

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