The end of Big Oil is nigh

25 December 2015 9:56 am

With oil now trading at $39.10 a barrel and Goldman Sachs predicting it will trade in the $20s, it’s quite clear that the oil price is heading south. And that's going to create problems for Big Oil.

The big losers will be governments in oil-producing countries. They will run down reserves and borrow in financial markets for as long as possible, rather than cut public spending. That, after all, is politicians’ preferred approach, especially when they are fighting wars, defying geopolitical pressures, or confronting popular revolts. Hello Vladimir Putin.

Western oil companies will stop oil exploration and seek profits by providing equipment, geological knowhow, and new technologies such as hydraulic fracturing (“fracking”) to oil-producing countries. Their ultimate goal will be to sell their existing oil reserves as quickly as possible and distribute the resulting tsunami of cash to their shareholders until all of their low-cost oilfields run dry.

In the meantime, oil companies are pulling back on exploration. As The Wall Street Journal tells us. exploration spending across the global oil industry was forecast to fall an average of 30 per cent in 2015 from last year’s $70 billion. US oil giant Exxon Mobil cut its capital and exploration expenditure by 16 per cent in the second quarter of this year compared with the corresponding period a year earlier. We can expect that to continue in 2016.

OPEC meanwhile led by Saudi Arabia is pumping out more oil to maintain market share against the US shale oil which is being financed by cheap debt. OPEC maintains that global reliance on oil and gas will continue unchanged for another quarter century. Fossil fuels, OPEC says, will make up 78pc of the world’s energy in 2040, barely less than today. They are simply ignoring pledges made by world leaders in Paris to drastically alter the trajectory of greenhouse gas emissions before 2040.

The problem is that advances in clean energy may well turn much of their oil into a worthless “stranded asset” that can never be used or sold. For example, electric cars could kill, or at least badly damage OPEC. Volkswagen is to unveil its "completely new concept car" next month, promising a new era of "affordable long-distance electromobility." Electric cars are likely to fuel BMW’s growth and Ford recently announced it would be spending $4.5 billion to bring 13 new electric or hybrid vehicles to the market by 2020.

Mark Carney, Governor of the Bank of England, has warned that vast reserves of oil, coal and gas will be “literally unburnable”, creating a stranded-asset problem could threaten global financial stability.

The bottom line is that the “carbon budgets” implied by global and regional climate deals render fossil-fuel reserves that oil companies’ balance sheets currently value at trillions of dollars totally worthless.
What we’re seeing is environmental pressure now interacting with technological progress, reducing prices for solar energy to near-parity with fossil fuels.

As technology continues to improve and environmental restrictions tighten, it seems inevitable that much of the world’s proven oil reserves will be left where they are, like most of the world’s coal.

And that means oil companies will either have to get out, or innovate. But their business model is stuffed. As is OPEC's.