There is no doubt 2016 is going to be a difficult year for energy exporters, including Trinidad and Tobago. Inflation-adjusted oil prices have experienced a lot of volatility over the last 70 years; however, the recent decline was relentless, unpredicted and to some extent unpredictable. There is a future, but one has to think strategically about how to get there.
The market is volatile because, at least in the short term, both supply and demand are relatively elastic, which means that small changes to supply or demand tend to cause very large changes to prices. Were there more stabilising speculations and low-cost storage capacity, we would presumably see these large swings buffered by intertemporal arbitrage. Generally, the Organisation of the Petroleum Exporting Countries (OPEC) has played that role. Saudi Arabia especially has provided a price stabiliser in the context of modest changes in global supply and demand. This time, Saudi Arabia and OPEC maintained supply, almost totally unresponsive to the fall of prices.
Nevertheless, this is not an energy-only phenomenon, but rather one of primary commodities. The main determinant is the market re-assessment of the future prospects of China’s economic growth. China has been the main driver of the optimistic view of an insatiable global demand for primary commodities. There is now a near consensus that super-charged growth is over for good, the main reason being that China has substantially converged towards frontier markets. Other factors behind the primary commodities crisis include the US dollar appreciation, which explains up to 20% of the oil price decline; the expectation of a hike in US interest rates; and financial markets underestimating fundamentals.
In terms of fundamentals, China’s year-on-year growth, which has regularly been above 10%, is now forecast by the IMF to be around 6% between 2016 and 2020. This is a plausible estimate, and my view is that $30 per barrel is too low a price for a China that continues to grow at 6% per year. Economists can point to other signs that a $30 oil price is too low. The long-term supply curve of oil requires oil prices well above $30 per barrel. BP’s long-term oil supply curve suggests that the Middle East could produce profitably at $40 per barrel; the marginal cost of other conventional oil requires maybe between $30 and $60 per barrel. As production becomes more and more unconventional, the marginal cost rises; shale oil requires a minimum of $50-60 per barrel. If shale were the major cause of this price swing, it is clear that it wouldn’t survive at current levels. Offshore development, which is more relevant to T&T, and unconventional oil sands (as in the Orinoco region or Canada) have an even higher marginal cost. This matters because the long-term price of oil will be what we believe the long-term supply of oil has to be. For instance, if we believe that oil sands are a critical marginal supply for a growing world economy, then we are actually stating that the long-term price has to be $80 per barrel or above.
Personally, I believe that long-term demand is likely to draw from conventional oil, and therefore at $50-60 per barrel at current prices. The reason I do not place the marginal oil unit with oil sands, offshore, ultra-deep or arctic oil is climate change. A world economy that relies on marginal energy being recruited from high-cost fossil fuels is simply not consistent with our climate goals.
There is no scientific doubt that the planet is warming, and it is warming because of the combustion of fossil fuels. The year 2015 was the hottest since records began – 1°C warmer than pre-industrial temperatures. The last time Earth was 2°C warmer than the 1800 average was 130,000 years ago in an interglacial period called Eemian, when the sea level was five metres higher than it is today. T&T is a low-lying coastal nation and five metres would have a devastating effect locally. The increase in sea levels will not immediately follow an increase in temperature, as no one knows how long it will take for the ice sheets of Antarctica and Greenland to break up, but it does mean that this 2°C warming that we are trying to fight is a serious matter. Avoiding this requires a substantial global shift in the emissions curve. It is a gradual transformation that cannot be delayed any further without risking the disappearance of several low-lying areas of the world, including T&T.
The very tough implication is that we can’t use the various fossil fuels that exist geologically, or even the reserves that have been discovered so far. If we burn all the coal, oil and gas that we know to exist, we will violate the carbon budget many times over. A study conducted in 2015 tried to estimate how much of the proven reserves need to be kept under the ground in order to live within the 2°C carbon budget. The answer is most of the coal, half of the gas and a third of the oil. This is a tough message and implies that we should move to renewable or nuclear energy soon. Energy companies that invest in high-cost hydrocarbons, on the grounds that the world economy will need a certain amount of energy in the 2030s, should not be startled if by then most of the energy demand is fulfilled by solar, wind, hydro, geothermal and nuclear sources. All economies will need a deep de-carbonisation strategy built on energy efficiency, zero-carbon electricity and vehicle electrification for collective survival purposes.
None of this is easy news for a country like T&T, where hydrocarbons are important to GDP and therefore the country’s well-being and development strategy. When the government says it has to raise taxes and cut spending, they are right. Incomes have fallen beyond the country’s control. This situation poses several other questions beyond the short term, including the set of decisions T&T and the Caribbean have to make, not only with respect to energy production, but also resiliency. The region has to take the Paris climate agreement seriously, because its own survival depends on it.
For T&T in particular, the challenge is also to come up with an energy strategy that is compatible with global realities. All energy-exporting countries have to ask themselves which investments can work within a 2°C-limited world. In this world, the price of oil is not $100 per barrel, as that would imply too much supply for that budget not to be broken. As a framework for development, one thing I would commend is the UN global agreement reached in September 2015. All 193 member states of the UN signed a new framework for development, which puts economic development, social fairness and environmental sustainability at the same level as global cooperation. The 17 goals adopted by the world’s governments must guide T&T’s decision-makers for the 2016-30 period.
Economic diversification is a fundamental part of the response to the climate and energy reality. To this end, T&T has to develop its exports, global competitiveness and business promotion by investing in education and innovation. Empirical evidence shows that there is no way to diversify an economy other than through education. In terms of educational performance, although T&T is not by any means at the bottom of the world’s rankings, it is not where it should be. Quality education should be the number one goal of this government and any future government. Expanding into new technologies is the only way to be competitive today. Case study analysis proves that technological excellence requires strong universities connected to an innovative business community. According to official data, T&T invests in research and development at around 0.05% of GDP, compared to the 3-5% invested by high-technology countries. To get started, the government has to play a leading role in investment and work with different industries to find a technology niche that can be developed in the country and then marketed to the rest of the world.
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