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Oil-Producing Nations Relent In An Era Of Lower Prices

Declared dead prematurely in 2018, the era of lower-for-longer oil prices is eating into the coffers of oil-dependent nations and forcing many to loosen fiscal terms to keep international investors happy.

They have little choice — at least if they want to keep the oil flowing. The American shale oil revolution has flooded global markets with cheap oil, putting an end to the heady years when oil topped $100 per barrel. At the same time, the world’s accelerating transition to renewable energy, buttressed by carbon taxes, has shifted the prevailing calculus: the incentive to sell oil while there is still a market for it is growing, a dynamic that could force long-term prices still lower.

Both developments have stolen leverage from oil-producing nations and handed it to international oil companies. Globetrotting goliaths like Shell or ExxonMobil hardly need stick around if a host country refuses to lower taxes when prices fall. They can pack up and head elsewhere.

“[O]wners of higher-cost resources will need to offer increasingly attractive contracts and fiscal terms to ensure their oil remains competitive and able to attract the private-sector investment needed to extract it,” according to BP’s chief economist, Spencer Dale, and the director of the Oxford Institute for Energy Studies, Bassam Fattouh.

In other words: the jig is up.

Reading the writing on the wall

One by one, they have yielded.

After three painful years of economic stagnation, Angola recently slashed headline tax rates on smaller oil fields from 20% to 10%, while its state-owned energy giant, Sonangol, is selling off non-core assets. Little wonder: since the oil price crash of 2014, companies have scoffed at the large upfront costs Angola demanded in exchange for fresh capital spending on the large offshore rigs required to dredge oil from beneath the ocean there.

In Algeria, where years have passed with scant new oil investment and the economy has sagged, the lower house of parliament last month passed a measure that would reduce taxes on oil and gas extraction. The bill still faces passage in the upper chamber, but experts say that lowering taxes is critical if the country wants to revive its oil sector. (As in Angola, oil revenue provides more than 90% of Algeria’s foreign exchange earnings.)

Both OPEC members may well be trying to replicate the success of a third. In July Gabon lowered taxes and relaxed state ownership over the oil sector, part of an overhaul of its hydrocarbons code. It was a gusher: Gabon recently signed several new contracts with oil producing firms, including Houston-based Vaalco and Malaysia’s state-owned group Petronas.

The trio of OPEC nations isn’t alone. In India and Indonesia, reforms to meant to entice investors are underway. In licensing rounds that the UK held in 2017, new types of licenses with flexible terms were on offer.

Others could soon follow in their footsteps. In October, Russia’s energy minister said that unless Russia lowered taxes it would soon become uncompetitive with oil producing countries such as the United States, where oil-rich shale fields have lured investors from around the world with their lower capital costs.

Yet not all are following this trend. The oil industry in Nigeria, Africa’s largest oil producer, champs at the bit for an investor-friendly overhaul, a part of which is named the Petroleum Industry Governance Bill, that has languished for years. But under the leadership of president Muhammadu Buhari — who has a penchant for state intervention — Nigeria may actually increase taxes on deepwater oil production, a move that the International Energy Agency warned in November “could make investments far less attractive and threaten future development.”

Ironically, if Nigeria does push through the tax increase, it would be doing so largely because it badly needs to replenish revenues that have gone missing since a mid-2014 oil price crash. New taxes would surely generate short-term revenue. But if investor sentiment suffers, Nigeria may well decide in coming years that it simply can’t hold out against the tyranny of low prices.

Stuck in the down position

Carole Nakhle, an energy economist, has a word for the ebb and flow of the fiscal conditions that oil-rich countries impose on oil companies: the “pendulum effect.” When oil prices rise, host countries ratchet up taxes and other terms to squeeze a larger share of profits out of companies. When prices fall back down, countries lower taxes back down again. They can’t afford the risk of scaring away the companies, whose expertise is crucial in getting the black stuff out of the ground.

Since a massive collapse of oil prices in 2014, the pendulum has been swinging down again. Except this time there may be no swinging back up.

When Saudi Arabia turned on the taps in 2014, in a bid to drive American shale oil producers out of the market, prices collapsed by more than 50%. Oil companies slashed capital spending, investing $779 billion in 2014 but only $583 billion in 2015. Today, prices have recovered but remain well below a decade ago, and oil firms still probably can’t recover costs at oil fields with breakeven prices below $60, according to Rystad Energy. So they’ve mostly steered clear of any countries, like Angola or Algeria, that hadn’t relaxed their fiscal terms.

In worse news for oil producers, a consensus is forming that oil prices may never again reach the heights of 2013 and early 2014, at least not for any long period of time. Anytime oil prices again rise too high, the thinking goes, resilient US shale oil producers will come back online in droves, boosting global supplies and pulling prices back down again. Nor is it likely that oil demand will sustain a renewed rise in prices. Economists anticipate that the world’s demand for oil — currently running at some 100 million barrels per day — could peak sometime in the mid- to late-2020s and decline thereafter. As producers scramble to sell their oil reserves while there is still a market for them, prices could tumble further.

It has taken some time, but the spate of oil-producing countries which have begun to lower the drawbridge to investors — including many in Africa, where capital is notoriously flighty — is a sign that reality has caught up with them, experts say.

“Lower oil prices drive political acceptance and support of investment,” Nakhle wrote last year. “In today’s climate, pro-investment policy reforms are more evident as countries compete harder for global capital.”

The era of lower-for-longer oil prices era has also handed leverage back to the majors. Giant companies like ExxonMobil, which makes a quarter of a trillion dollars annually and operates around the world, have little incentive to stick around in a given country if the government refuses to lower taxes on oil extraction; they can simply head elsewhere. In fact, whether a country has friendly investment terms or not is arguably the most important criterion for investors. The additional costs imposed by fiscal regimes are the largest single source of cost differences among oil-producing nations, according to data from Rystad Energy. In other words, for firms, the oil itself matters less than the terms attached to it.

Companies may also be benefiting from a fundamental shift in the nature of energy markets. In her 2017 book “Windfall,” Harvard’s Meghan O’Sullivan argues that the US shale revolution, in addition to robbing market share from OPEC and its allies, has shifted the power balance away from producers back toward consumers and the companies that supply them. If oil is abundant and comes from a variety of sources, companies need not pay fealty to a given country or countries. In an apt illustration of the principle, O’Sullivan recalls how, in 2014, Russia’s state-owned Gazprom cut off gas supplies to Ukraine, which had no other ready source of gas. It was a blatant exercise of power, demonstrating the power that producers enjoyed over consumers. Since then, though, a profusion of US natural gas supplies has created new markets, including across the Atlantic. Russia would probably struggle to starve Ukraine of gas today, since Ukraine would able to access supplies from Europe. (It would still be painful.)

Of course, unlike natural gas, oil has long been a global market, with tankers sailing around the world for decades. Nevertheless, with projections showing that the US is poised to join Saudi Arabia and Russia as top oil exporters and Brazil anticipating its own production growth spurt, the source of global flows of oil are steadily becoming more diverse.

“In the past, when oil production was more concentrated, [producers] could act more like a cartel and keep prices [e.g., taxes] high in the face of decreasing demand,” said Ben Ho, a former lead energy economist at the White House Council for Economic Advisers. “With more competition, oil producing countries have less market power and therefore respond more immediately to shifts in demand.”

As oil prices drift lower, what of development?

For now, oil prices have recovered. The price of a barrel of Brent crude touched $52 a year ago, but a recent trifecta of extended production cuts by OPEC and its allies, a tentative US-China trade deal, and unexpectedly strong global growth have pushed the price back up above $65 per barrel.

Still, few doubt that in the long term prices will come down and stay down. In an email, Ho wrote: “I think there is a general expectation that both in the near term (potential for global recession which always has a big demand effect) and the long term (as new oil technologies, not to mention climate change regulation and electric cars) will dramatically bend the trajectory of future oil demand and thus future oil prices.”

What does that mean for many developing nations, who have long depended on their ample oil reserves for economic growth? Some observers say the oil slump of 2014 jolted these countries out of their complacency. If access to plenty of oil is in fact a “disease” — in that it enables countries to forego difficult reforms, such as implementing taxes and rooting out corruption — then the hard reality of terminally declining oil revenue could be a welcome shove in the direction of needed reforms.

Angola is a case study in the corrupting power of oil wealth and a sign of what could lie ahead. Between 2002, the year it staggered free of a 27-year-long civil war, and 2010, oil production soared from 300,000 barrels per day to a peak of 2 million. Angola’s gross domestic product (GDP) hitched a ride, rising from $15 billion in 2002 to $146 billion in 2014. As recounted in A Magnificent and Beggar Land, a post-civil war history of the country, these were years of excess. Under longtime leader José Eduardo dos Santos, Angola built up its gleaming capital Luanda into the world’s most expensive city for foreigners — “the facade of modernity, and to hell with the plumbing” — but its industrial ventures often amounted to imitations of productive enterprise rather than the genuine article. Poverty remains widespread and corruption is among the worst in the world. Transparency International ranks Angola 165th most corrupt out of 180 nations.

Yet today there are signs of change. President Joao Lourenco, who took office in late 2017, has so far taken all the right steps to begin to tackle corruption, experts say, and the country is working harder than ever to diversify its economic base away from oil.

The party may be ending, but the work has begun.
Source: Forbes

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