Facing the great oil glut

December 4, 2015
Herald Sun
We should be in for a protracted period of easing prices.
COULD petrol prices be heading back down to that magic $1 a litre level?
It is looking increasingly likely that we will get there, or at least very close, as a combination of plunging crude oil prices and a slightly firming Australian dollar eventually flow through to the bowser.
While there are many moving parts in petrol prices, including the current rise in retail margins and normal price cycles, eventually the dramatic and continued fall in the underlying price of oil should act like gravity and pull down the hip pocket cost.
Oil is also one of those rare commodities that influences the price of almost everything we buy and use — right down to every item on the supermarket or clothing shop shelf right through to plastics, gas, chemicals and everything that is imported on a ship.
So as oil prices now fall to below $US40 a barrel with every indication of a developing glut, we should be in for a protracted period of easing prices as the oil component filters through to many everyday products.
The reasons behind the oil glut are many and various but they are seen most graphically in the queues of oil tankers that are building up off the coast of Singapore, China, Venezuela and the US.
It is the exact reverse of the situation during the mining boom when coal ships were queuing up off the coast of Newcastle waiting to get hold of coal to ship to eager customers.
Now tankers full of oil are waiting for up to a month to unload and with oil storage facilities filling up, there is every indication that this oil glut will take at least a few months if not much longer to begin to clear.
The geopolitical and business roots of this oil glut are fairly easy to identify.
At its heart is the technological advance in the US of shale oil, which has turned the world’s biggest economy from a massive importer of oil into potentially an exporter in the future. This alarming development caused panic in major producer Saudi Arabia, which decided to tackle this new, unpredictable and non-OPEC source of supply head on by cranking up its production.
The theory was that the unconventional US oil producers would be forced out of the market as oil prices fell below their cost of production but it is an experiment that has only partly worked.
While the shale oil players have certainly scaled back drilling to expand their discoveries, many have continued production from existing wells just to keep some cash coming through the door even as the oil price has dropped a full 60 per cent from its most recent highs.
When you add in slowing oil demand from China, more efficient and less oil-intensive use in the developed world, tepid world economic growth and rapidly rising supply from Iraq and price competition from Russia, you have an almost perfect recipe for an oil glut.
Gone is all the talk of reaching peak oil production followed by rocketing prices as demand rises and supply diminishes.
While peak oil is a genuine scenario, the advent of unconventional shale oil, which is still in its relative infancy in world terms, has changed the projected time frame dramatically.
The overall result has been the same as for any imbalance between demand and supply — the oil price has fallen sharply and will continue to do so until the higher cost producers fall by the wayside, either by going broke or just going into care and maintenance.
It is only when supply is curtailed and/or demand increased that some balance will return to the oil market and prices can start to stabilise or rise.
For the world as a whole, cheap oil is a mixed benefit, with the oil producing countries going through a period of intense hardship and the oil consuming countries enjoying the equivalent of an economic stimulus.
Here in Australia, the direct benefits at the bowser have been muted by the fall in the Australian dollar but still there has been a distinct boost from lower prices.
At a corporate level this is most obvious in the fortunes of big oil consumers such as Qantas and Virgin, who have had their profit numbers turbocharged as their costs fell and fares remained steady.
It is a very different story for the oil and gas producers such as Santos, Woodside and Origin Energy.
Overall, Australia is an oil importer so the lower prices should be a spur to activity.
AIRLINES WILL BE UP FOR A FIGHT
GET ready for the mother of all fights between the airlines and the Reserve Bank.
While it might be hard to detect from the bank’s draft standards on credit payment systems, the pressure is being applied squarely to players such as airlines and Cabcharge to slash the lush fees they charge on the use of credit cards.
Specifically for the airlines, the practice of charging a set dollar amount in “booking fees’’ for the use of credit cards for every single ticket rather than every transaction is set to be tackled through the use of a set percentage.
While the airlines have long argued that they make a loss on accepting cards, the Reserve Bank is throwing down the gauntlet by insisting on a set, small percentage that reflects the actual cost of accepting the card.
In another move that will hit the frequent flyer programs, lower interchange fees for the use of cards is also likely to reduce the number of points that credit card companies generate from these transactions.
So it will potentially take a much higher level of credit card rewards spending to generate a given flight — plus the potential for higher annual card fees for those that offer the most generous rewards.
Getting the new rules adopted in practice will be difficult given the different creative ways charges can be added but there are some strong benefits if the new RBA rules can be successfully implemented.
One is to reduce direct consumer costs and to reduce the Kath and Kim-style acquisition of points for their own sake.
Another is to ensure that each credit card in your wallet performs its main task of purchasing items cost effectively without too many distractions from the bells and whistles of reward programs.
It will be interesting to see how the airlines respond but they are unlikely to take a dual assault on their rewards programs and their booking fees lying down.