Gadfly: Oil Revives the Disco Inferno, But With Less Heat
This opinion piece presents the opinions of the authors.
It does not necessarily reflect the views of Rigzone.
(Bloomberg Gadfly) - Imagine if, instead of a trip to Whole Foods, your grocery shopping involved a trip to your city's sketchiest neighborhood to barter with a handful of store owners who occasionally shut you out or start smashing each others' windows.
Well, that's actually how you buy a lot of your oil.
Fortunately, you don't personally have to pop over to the Middle East to pick up a barrel every time you need it. But you (and I) rely, directly or indirectly, on that fractious region for about a third of our oil. What's more, despite what you have read about the U.S. shale revolution, reliance on the Middle East has been creeping up. Fatih Birol, who heads the International Energy Agency, warned in an interview with the Financial Times that Middle Eastern producers' share of oil production is back to its highest since the 1970s.
Let's face it, the 1970s were great for, say, Donna Summer; not so much for the oil sector. Thankfully, that market share chart tells only half the story.
Today's competitive landscape is completely different. The oil crises of the 1970s spurred production from other regions outside of the Middle East and, more broadly, OPEC. The more recent oil shock, spurred by the surge in demand from emerging markets, chiefly China, did the same.
The biggest development this time has been the opening of U.S. shale. Relatively quick to develop and having made big strides in productivity, shale output has pushed prominent OPEC members such as Saudi Arabia to re-evaluate the wisdom of holding barrels in the ground to support prices. This has, in turn, led to infighting in the cartel's ranks, especially given existing political and economic divisions.
So while the Middle East's importance has risen, the overall level of competition is nothing like what it was back in the day. I've plotted out market concentration in the chart below, using the shares of major oil producing countries as reported in BP's Statistical Review of World Energy. Concentration is measured using the Herfindahl-Hirschman Index, used by regulators when assessing mergers. The Department of Justice generally considers a score of between 1500 and 2500 to indicate a modestly concentrated market, with anything above 2500 highly concentrated. On here, I've plotted out three scenarios: Every country for itself, a fully functioning OPEC, and a functioning 'core' OPEC made up of four generally aligned Persian Gulf states: Saudi Arabia, Kuwait, Qatar and the United Arab Emirates.
As you can see, were OPEC functioning properly, it would have reasonably strong market power. You can also see its core members have accounted for much of the increase in output from OPEC's ranks in the past couple of years, nudging the score back above 1000 in that scenario -- still not a level regarded as even modestly concentrated.
One other thing to note is that uptick in concentration since 2009 even in the free-for-all scenario. It is largely misleading, as 80 percent of it is due to increased output from the U.S. And the U.S. oil sector definitely can't be treated as monolithic: The top ten producers account for less than a third of the country's output, according to Rystad Energy, a consultancy. Adjust the index for that, and the free-for-all score for 2015 would drop to just 502.
The oil market may be less concentrated than is generally thought in one other important respect: reserves. According to BP's annual study, 71 percent of the world's proved oil reserves are held by OPEC countries. There are two issues with the data. First, proved reserves don't necessarily capture the true extent of resources such as shale. Second, figures for OPEC countries are often based on official figures from those governments, which use different methodologies (including, perhaps, a hefty dose of national pride).
In a report just published, Rystad Energy took a stab at estimating proved plus probable and potential reserves, based on looking at 60,000 wells or clusters of them. This paints a very different picture.
Rystad's figures are, of course, just another set of estimates. But given the radical changes in oil supply in just the past eight years, would it really come as a surprise that shale's potential is still a moving target?
The point is that the IEA is correct to point out that the Middle East's well-being remains crucial, with its share of output back to levels last seen when roller disco was a thing. Equally, though, like the music scene, the oil world has moved on.
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