Cheap oil with caveat Winarno Zain  ;  An economist and commissioner of a publicly listed oil and gas service company

JAKARTA POST, 03 Februari 2015

                                                                                                                                     

                                                

When King Abdullah of Saudi Arabia died last month, speculation was rife that oil prices would move from the current level. But after Prince Salman was appointed the new ruler, it was clear that the new king would stick to the policy of his predecessor, holding Organization of the Petroleum Exporting Countries (OPEC) oil production steady amid declining prices to defend Saudi Arabia’s market share. That means oil prices would remain low and as Saudi Arabian oil minister Ali al-Naimi said, the oil price per barrel would not return to US$100. The low-oil prices will remain for some time, since the steep fall in oil prices were the result of ongoing structural changes in the global oil economy. There are several forces that have driven down oil prices. First, production of shale oil in the US has expanded, enabling the US to reduce its oil imports, increasing supply in the market by nearly 1 million barrels per day. Shale oil companies in the US have drilled 20,000 wells since 2010 (about 10 times that of Saudi Arabia’s wells) and have contributed one-third of the 9 million barrel per day (bpd) of US production. Second, weak economic growth in developed economies such as Euro zone countries and Japan, as well as weakening growth in China have curbed demand for oil. Third, changes in OPEC policy objectives. Saudi Arabia, which normally acted as a swing producer for OPEC, decided to change its policy into defending its market share. Despite the plunge in oil prices, Saudi Arabia did not cut its oil production and according to some reports, it even offered discounts to some traders. Fourth, the continuing strength of the US dollar, with which oil prices are denominated, have made oil too expensive for countries whose currencies are weak, forcing them to reduce demand for oil. Fifth, geopolitical risks have played a smaller role in influencing oil prices. Markets were surprised to see oil production increase in countries such as Iraq and Libya, where armed conflict is raging. Declining demand for oil has stemmed from the continuous effort to save energy since the 1970s, resulting in less energy intensive gross domestic product (GDP) growth. The plunge in oil prices has blessed Indonesia with unexpected windfall benefit, making it easy for the government to implement subsidy reform smoothly. Fiscal burdens from the fuel subsidy and pressure from oil imports in the trade balance would ease considerably. But the fall in oil prices would bring several adverse effects that the government would have to deal with. On the fiscal side, it cuts government non-tax revenues significantly since Indonesia remains an exporter of oil and gas. A more serious impact will be felt in the oil and gas industries. The immediate impact of the sharp drop in oil prices for Indonesia will be the slowdown in exploration activities. Even before oil prices fell sharply, exploration activities had slowed due to various reasons such as legal and fiscal uncertainties. The high cost of exploration has made investment in oil and gas exploration in the country more and more unattractive. Last year, according to the Upstream Oil and Gas Regulatory Special Task Force (SKKMigas), out of 206 planned oil-drilling projects, only 77 were realized, down from 96 in the previous year. Exploration spending fell from $1.9 billion in 2011 to $1.2 billion in 2013. Oil production has continued to decline from 346 million barrels in 2009 to 301 million barrels in 2013. According to the Energy and Mineral Resources Ministry, several oil and gas contractors are considering halting their projects because low-oil prices have hurt their profit margin. Some big oil contractors such as US company Chevron and the French Total may be able to sustain their exploration activities in Indonesia, but if oil prices remain at the rock bottom level, they will scale down their exploration activities too. Drilling activities to discover new reserves for fossil fuel and any findings could determine the potential for future production. If drilling activities keep declining, Indonesia will have less probability for finding new reserves and this will impact its future production. The development of alternative energy projects, especially renewable energy, could suffer a setback. The low prices of fossil fuel would bring competition to these projects. Under pressure from low-oil prices, alternative energy projects would not be commercially viable. As developments for these projects slow down, fossil fuel will continue to dominate energy consumption and the country’s dependence on imported fuel will drag on. The government has announced a plan to set a floor price for domestic fuel. Floor price is the price that the government would maintain regardless the extent of the continuing fall in oil prices. The aim is to guarantee a certain amount of government revenue from oil and gas to safeguard its fiscal sustainability. For investors of alternative energy, this policy could signal price competition. From this they could calculate to what extent their projects would be commercially viable. In any case, cheap oil could threaten the national goal of diversifying energy usage. Moreover, low-oil prices, if sustained over medium-term, may encourage production that is more intensive in fossil fuel or energy generally. This runs counter to the national policy of achieving a cleaner environment. The rapid changes in the global oil economy should alert the government to design a new energy policy, where taking benefit of low-oil prices has to be balanced with providing better incentives for the development of alternative energy, especially renewable energy. Otherwise, the goal of achieving national energy security would be in disarray. ●