Comment: Supply & demand can take years to balance

The supply of oil is currently outstripping demand. Picture: TSPL

The supply of oil is currently outstripping demand. Picture: TSPL

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THERE has been a worrying fall in the oil price over the past seven months from around $110 a barrel to about $50 a barrel at the moment.

This is because there is simply more supply of oil than there is demand.

On the demand side, we see a weakening in some of the economies around the world – a slowdown in China and a slowdown in the eurozone – and that has quite an impact on how much demand there is for oil.

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On the supply side, there is a lot of new oil coming on stream – particularly in North America on the back of shale oil. The North Americans have been very successful in developing shale oil on the back of their fracking technology.

What we now see playing out is that Opec [the Organisation of the Petroleum Exporting Countries] is keen to maintain its market share. The way to make sure that you maintain market share is to reduce activity in terms of oil and gas investment.

The oil price is now being used as a lever to reduce activity. At a lower oil price, you will make less investment and less investment means less production and, therefore, over time it will balance supply and demand.

We are already seeing a reduction in the number of new wells being drilled in North America.

But what is more worrying is the effect of the oil price on areas like the North Sea, which is traditionally a higher cost basin. The North Sea is likely to experience a disproportionate impact from the low prices simply because the costs to extract oil there are higher than in most other regions.

In terms of the forward market, everybody expects that, over time, supply and demand will balance and it is expected that prices will eventually increase over time. However, it can take a number of years for this to happen. We are already around seven months into that period, so there is still some time to go, unless we see intervention in the market by Opec or others.

It is really important for industry and government to work together to make sure we have a successful, vibrant North Sea for years to come. There is an opportunity to focus on various areas.

One is to provide incentives to do more exploration. If we don’t find oil, you can’t produce oil. We also must incentivise investment and have a competitive tax regime overall.

At the moment, the UK government takes between 60 per cent and 80 per cent of profits. The tax regime needs to reflect the reality of the North Sea basin and at the moment we are at risk of making the basin uncompetitive.

Finally, the industry itself has a key role to play to improve its own efficiency.

Professor Paul de Leeuw is director of Robert Gordon University’s Oil and Gas Institute.

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