Oil rig (2)

The oil price rose again yesterday as OPEC and Russia came to a new agreement – but they seem to face an impossible challenge.

The oil price matters rather a lot – it is surely no coincidence that the advanced world has seen its best economic performance since 2008 in the last three years, at a time when the oil price has been relatively cheap.

To remind you, back in 2013, oil was trading at around $100 a barrel. It now seems to be trading in a corridor of between $45 and $55. In theory, cheaper oil should have a negligible effect on the global economy. All that happens when the price falls is that global GDP is re-distributed from oil producers to consumers. But, in reality, oil producers tend to see a much higher savings ratio, so a cheaper oil price should lead to higher aggregate global demand.

In fact, look back over the post war years, economic boom often coincided with a period when oil was cheap – the late 1990s and early noughties for example, the UK saw its longest ever run of uninterrupted economic growth. Then the oil price shot up in the mid noughties, in the year preceding the 2008 crash.

Now OPEC is reportedly, in conjunction with Russia, set to extend its 1.8 million barrels a day oil production cut for another nine months.

But the problem is this: Old fashioned oil wells cannot be turned on and off. Fracking activities can.

Fracking is the F word to OPEC – the jury is out whether it is an F word to the environment.

Imagine an oil well is shut down because the oil price has fallen to a level so that the well is no longer economic. And then the oil price picks up – re-completing that oil well is very expensive, much of the set-up costs have to be paid for all over again.

With fracking, the biggest costs relate to the huge volumes of water that are injected below the ground. This is a variable cost.

Over the last two or three years, US oil production has oscillated with the oil price, when the oil price falls close to $45, fracking activities slowdown, when it moves to $55 they speed-up.

This has led some to say that the oil cycle is dead, oil will never return to the dizzy heights seen in 2008.

Maybe, but then in 2008 people talked about peak oil, they said that the world was running out, and that the oil price would never fall below $100.

The oil cycle will surely turn again – eventually, as oil producers find they simply cannot afford to stay in business, and then global supply plummets. But that time seems to be several years away, for the time being, the global economy is set to do quite well – by recent standards.