I had to think twice before writing the title for this piece. I wrote the words ‘low oil prices’, and then realised that what we call ‘low’ today would have been considered ‘high’ just five years ago, and almost ‘very high’ ten years ago when the annual average price for Brent crude oil (from the UK) was below US 13 per barrel. As an economist colleague of mine says to students: something can only be high or low in comparison to something else. In the case of oil prices, it can be in comparison to prices at a certain previous time or in comparison with previous expectations of future prices.
What is critical today is that prices are low in comparison to expectations just one year ago, in December 2007, when prices were hovering just below US $ 100 per barrel. The pundits were telling us to get ready for US $ 150 and possibly US $ 200 per barrel. In early July 2008 the price of Brent crude oil nearly did reach US $150 per barrel, but since then it has declined to about US $ 40 per barrel at the time of writing. The strengthening of the US dollar has somewhat offset this decline for some importing countries.
The implications for China, and for other oil importing states, are of two main types: those which arise from the behaviours of external actors and those which more directly relate to domestic policies.
Let us look first at the external actors. OPEC as an organisation has the potential to reduce oil production in the short-term, and everybody will be watching the meeting to be held in Algeria on 17th December 2008 to see if they decide to cut production and by how much. Then we will be watching to see which OPEC member states break their pledges and produce more than their allowance. For we have to realise that many OPEC countries will face budgetary challenges of varying degrees of magnitude in 2009 – for their expectation was for prices to be close to US $ 100 per barrel.
Linked to the OPEC decision, but of much greater importance, is the response of those who invest in future oil and gas production. Oil prices may have plunged, but costs have not fallen as fast and are unlikely to reach the levels seen in the 1990s unless oil prices remain low for several years. As a result, projects which have been prepared during the last three or four years have been postponed because they had an oil-price threshold of US $ 60 per barrel or more to make a profit.
Thus, if we assume that the world economic growth will indeed pick up again to the sort of rates we have been seeing in recent years, then the challenge of a shortage of oil and gas production capacity will come back to hit us. Low prices will not solve this serious problem, they will merely postpone it. If investment in new production capacity continues to be too low, then oil prices will quickly return to US $ 100 or US $ 150 per barrel, or higher, as the world economy recovers.
This grim scenario will only be avoided if we realise that this recurring threat of high prices is indeed a signal: a signal to change the way we use energy. With oil prices, and indeed all energy prices, rising relentlessly since 2004, governments and citizens around the world were seeking ways to curb their energy consumption in the short term and governments were putting in place strategies to enhance the efficiency of energy use across their economies in the long-term. Some of these measures had been put into action, others awaited final approval, whilst others were just draft proposals. Despite the immaturity and incompleteness of some of the proposals, it was becoming apparent in late 2007 and early 2008 that a high degree of consensus was emerging amongst many governments that the need for combined action on energy consumption and climate change was becoming ever more pressing.
The question now is to what extent will this enthusiasm for clean and efficient energy use be dampened by the current economic and financial crisis? Will the next two or three years be used constructively to continue building on earlier policies and instruments to promote clean and efficient energy use, or will these years be lost as effort and funds are diverted to address the economic and financial crisis? Governments will have other concerns on their agendas, and most companies will have less money and less access to loans for investing in the development or deployment of new technologies and practices.
Thus if governments and industry players around the world reduce their level of effort and investment in new oil and gas production capacity and also in initiatives to use energy more efficiently, then when the world economy rebounds we will be just as unprepared to cope with the energy challenges as we were four years ago.
As a country which is both a major user of energy and a growing net importer of oil, these concerns are all relevant to China.
In the short-term China will see some benefits. The current low oil prices bring relief to previously rising amounts of foreign exchange required to pay for the oil imports. At the same time its national oil companies still have access to funds which will allow them to keep investing in new production capacity, both at home and abroad. For them it is a good time to pick up some overseas assets at a low price. The domestic Chinese oil refiners will at last see some relief from the many months of financial losses as crude oil prices rose progressively higher than the controlled domestic prices for oil products. Finally, the smugglers have temporarily been having a good time bringing in ‘cheap’ oil products from the international market and selling them into the domestic market where prices still have not been reduced.
China’s government announced in early December 2008 that, after fourteen years of debate, it is at last increasing the consumption tax on oil products by a substantial margin. The government will still retain control over pump prices in order to prevent excess fluctuations in response to international prices. At the same time they will increase subsidies to farmers, taxi drivers, forestry, fisheries and public transport, and provide the domestic refiners with a guaranteed profit margin when international prices rise again. In principle, this step will allow the government to send out, through the pump prices, economic signals which encourage people to buy efficient vehicles and to use them less wastefully. But this will depend, in part, on what guidelines the government uses to make adjustments to the pump prices.
This period of relatively low crude oil prices is also a good time for China to re-start the filling of its newly constructed strategic oil reserve. Indeed, I would not be at all surprised if this has not already started. The quieter the Chinese are about this, the less likely are the markets to react by raising prices and making it more expensive to fill these tanks.
But the big question for China’s government, as for all other governments, is whether the high priority given to energy efficiency over the last four years will be allowed to diminish, or whether the government will keep the pressure on all sectors of the economy to improve the way they use energy in the short and the long term.
As I discussed in last month’s column, the first announcements of China’s economic stimulus plan seemed to place a considerable emphasis on infrastructure, including roads and railways, and on new buildings. Whilst these are clearly desirable from the point of view of economic development and to promote short-term economic growth, the government needs to put in place strict measures to ensure that all the good work on energy efficiency of the last four years is not undone through the lax behaviour of enterprises and local governments. The closure of old power stations, steel plants and cement plants needs to continue and new plants need to meet high specifications. Likewise, new buildings should meet the building codes, and, more importantly, should add real value to the communities in which they are constructed.
These points are easy to make in writing, but extremely difficult to implement.
Philip Andrews-Speed is Director of the Centre for Energy, Petroleum and Mineral Law and Policy at the University of Dundee, UK