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