The changing nature of oil prices: Dr Mosongo Moukwa

The recent debate over falling oil prices has become an over simplified economic question of supply and demand, ignoring other interrelated economic considerations. Despite the global recession, oil demand has remained at 90-91 million barrels per day (mbd) for the past 5 years. Production has not peaked, despite much of the theorising about Peak Oil that has failed to recognise technological progress.
 
It has been quite awhile since Western nations have led the international demand. Because of the recession, they have reduced their demand. The actual rise in demand has been in Asia, and the price of crude oil follows accordingly.
 
A decrease in demand and an increase of supply has caused oil prices to fall over the past five years from an average of $110 to $85 per barrel this year. It is a striking fact that since 2005, all of the increase in the world’s crude oil production has come from the US. The talk about an ‘age’ of abundance in oil is justified only from a North America perspective. Production has risen considerably, and has the potential to rise further.

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The equation today is about the availability of affordable supply.
 
The way geographical events impact oil prices has also changed. In the past, events such as the Ukraine crisis and ISIS would have been enough to trigger a spike in the price of oil. But, not any longer.
 
The new matrix for oil prices
Oil prices now operate under a very different matrix than they did a few years ago.  This requires a reassessment in companies’ strategy. Profitability will no longer be simply tied to the rising price of oil and thus, raw materials. Instead, shareholders and investors will now look at returns and how companies are generating those returns, by providing innovative and differentiated products, and distributing them in a more efficient way.
 
It appears that the two most consistent and prominent risks to chemical manufacturers are market supply and demand imbalances and changes in production costs brought about by shifts in the underlying energy market. Indeed, chemical plants built today are designed for scale and continuous operation between maintenance shut-downs.
 
The risks facing chemical producers are hard to visualise, but they are very real and have the potential to significantly dilute or even eliminate their ability to leverage energy and raw material price differentials for higher levels of profitability. Key risks that are inherent to the forecast for the basic chemical and plastics industry include capital cost escalation, market access/trade exposure, stringent regulatory legislation (environmental and/or protective tariffs), significant market imbalances (shortages or oversupply) created by variations in regional supply versus demand growth, and unpredictable energy market dynamics.
 
The US chemical industry
The US is once again the top oil producer in the world, surpassing Saudi Arabia and Russia. It is estimated that the US will be pumping out an average of 12 million barrels a day of crude oil plus gas liquids, an all-time record level. When you add biofuels and volumetric gains from refining, the country is effectively producing 14 million barrels a day. The US can now rely on domestic sourcing to meet demand for the foreseeable future. It is expected that within the next decade, the US is heading toward oil self efficiency.

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This has implications for the chemical industry. The industry is betting on the fact that unconventional oil and gas will make North America the low-cost chemical-producing region of choice for years to come. Whether in the form of crude oil, natural gas, or coal, energy provides the basic raw material that is used in chemical plants the world over to produce higher-value basic chemicals, intermediates, and plastics.
 
These basic chemicals and plastics, in turn, represent the key building blocks from which a wide variety of durable and non-durable consumer goods are manufactured, including clothing, construction materials, household items, food and beverage packaging, and various modes of transportation. A crude oil price range between $85 and $100 a barrel will provide them with more than enough opportunities to profit.
 
At least, for now.
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Dr Mosongo Moukwa is Director of Technology at PolyOne, USA, and was recently an Independent Consultant based in Chapel Hill, USA,  and Vice President - Technology at Asian Paints Ltd, Mumbai, India. He is a member of the American Chemical Society and Product Development Management Association. Email: mosongo@mosongomoukwa.com