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Saudi’s oil game portents high energy prices

opec logoSaudi Arabia’s high stakes game of over-production in an already saturated (relatively) low demand market has intensified with the revelation that they have increased oil production to 9.8m bpd, its highest level since last Autumn.

Saudi’s latest market making action holds out the potential for increased periods of low prices with Khalid al-Falih, chief executive of Saudi Aramco warning:

“Supply and demand and the rules of economics will govern. It will take time for the current glut to be removed.”

Two things we’ve covered many a time need reiterating.

One is the scant influence that oil has on the wholesale cost of gas in the UK. With less than a third of European gas contracts still indexed to oil and only around 43% of UK gas being sourced from Mainland Europe, the direct influence of the oil price on the cost of gas is marginal with only around 6% of the total cost of gas in any way influenced by it.

The second is what many believe to be Saudia Arabia and OPEC’s raison d’etre, that is to flood the market with oil, causing dramatic reductions in price (down to $47 from above $100 at one point) and in so doing rendering uneconomic some of the longer term threats to the oil price. Or in other words Shale oil and gas of which the US is the biggest new player on the scene.

The shale revolution has effectively enabled the US to decouple itself from the global energy market, that is as a purchaser or importer of commodities. What it has also done however is led it to be able to play a new role in the market – export. Specifically exporting its excess coal and even biomass to the UK as supply burgeons at home.

The effect then of Saudi policy in driving down price has limited direct impact on the cost of gas but over the long term it could have wide reaching ramifications for the cost of electricity. With the UK currently benefitting from relatively low priced source commodities from such as the US with which electricity can then be generated this allows a lower overall retail price. Good news for UK business.

Indeed we’ve seen large falls in the wholesale cost as abundant supply of cheap(er) sources and muted demand due to benign weathers has created the commercial landscape we have today.

BUT, the Saudi pressure could come to bear on the economics of US shale and most certainly already is having a negative impact on North Sea Oil and the preparations for our own shale ‘revolution’.

The abundant supply of imported coal and biomass could be the next victim of OPEC’s objective as the US closes marginal shale plant and returns to traditional sources as the economics begin to fail.

The natural conclusion then is a swift cut in exports, our imports, and the UK needing to go elsewhere to source the generating commodity… Qatar for LNG, mainland Europe for the rest.

And that is the nub of the problem. We are not energy self sufficient as a nation. We are at the mercy of ‘external’ factors. If a country, a superpower even, undergoing an energy revolution can feel the pressure you can be darn sure we will feel it too.

Falling oil prices aren’t the manna to heaven many would have you believe, we may benefit at the pumps but ultimately we’ll pay at the meter.