Why is the oil price not about equilibrium?: An economic sociology account of petroleum markets

Why is the oil price not about equilibrium?: An economic sociology account of petroleum markets

Energy Policy 96 (2016) 45–49 Contents lists available at ScienceDirect Energy Policy journal homepage: www.elsevier.com/locate/enpol Why is the oi...

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Energy Policy 96 (2016) 45–49

Contents lists available at ScienceDirect

Energy Policy journal homepage: www.elsevier.com/locate/enpol

Why is the oil price not about equilibrium?: An economic sociology account of petroleum markets Andrei V. Belyi n Centre for Energy, Environment and Climate Change Law at the University of Eastern Finland, Finland

H I G H L I G H T S

   

Oil price is not about affordability but about social embeddedness processes. Producer-Consumer juxtaposition stems from resource-determinism concept. Elevated oil price postpones peak oil and favors inter-fuel competition. Important symbolisms surrounding the oil price exists in terms of business perspectives and political risk aversion.

art ic l e i nf o

a b s t r a c t

Article history: Received 30 November 2015 Received in revised form 28 April 2016 Accepted 2 May 2016

This opinion paper seeks to initiate discussion of the institutional and societal causes of oil price. On this basis, the social embeddedness concept is proposed instead of the frequently used producer-consumer juxtaposition. Observation shows no linearity between resource distribution imbalances and supply dynamics on the one hand and price on the other. As a socially endogenous factor, oil price generates practices and norms comprising benchmarks for resource valuation, stock market dynamics and risk aversion practices. A high oil price incentivises investments and inter-fuel competition, whereas a low oil price increases both political and market risks beyond the consumer-producer conceptualisation. Hence, it is argued that the notion of oil price affordability in energy security should be revised. & 2016 Elsevier Ltd. All rights reserved.

Keywords: Oil price Energy security Investments Inter-fuel competition Social embeddedness

1. Introduction Recent years have witnessed animated discussion about the oil price, its affordability and subsequent political and economic interactions. Producers, consumers, traders and financiers have all sought to find the right equilibrium for the price. A large proportion of the scholarly literature on the subject has emphasised the consumer-producer juxtaposition shaping international energy relations and affecting transnational oil markets (Kalicky and Goldwyn, 2006; Andrew-Speed, 2007; Florini and Sovacool, 2009; Vivoda, 2009; Ortung et al., 2009). I argue here that a different analytical path should be taken in order to achieve understanding of the oil price, which should be seen endogenously within a web of political, societal and economic interactions. The roots of the academic discussion stem from the 1973 oil shocks that impacted on energy policy studies in general (Sovacool, 2014). Since then, oil prices have often been viewed as unfair per se, n

Corresponding author. E-mail address: [email protected]

http://dx.doi.org/10.1016/j.enpol.2016.05.012 0301-4215/& 2016 Elsevier Ltd. All rights reserved.

while the Organization of Petroleum Exporting Countries (OPEC) has long been seen as a price-setting monopoly (see Colgan (2013)). Tracing the historical evolution of the oil price shows even more clearly that its ‘non-market’ features also existed before the oil shocks of the 1970s (Chalabi, 2010). It has also been argued that the development of trading platforms since the end of the 20th century and the liquid ‘oil-paper’ trade resulting from it still leaves the hydrocarbon sector within a different domain from other economic sectors (Mitchell and Mitchell, 2015). Among other things, even in the aftermath of the decline of OPEC's capability to have a direct impact on markets (Mabro, 2005) the oil price has surged on a number of occasions. Consequently, the manifest inadequacy of equilibrium-related explanations leads one to examine price-related processes more from a sociological perspective. In particular, it could be hypothesised that oil prices, defined hereafter as a form of institution, are not linearly linked to imbalances in resources. In fact, the opposite should be argued: oil prices condition the value of the resource. Therefore, oil price should not be explained in terms of a ‘right balance’ but must instead be viewed in a broader context. For similar reasons, the current market practices delink the low oil

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price from GDP growth (Tverberg, 2016). Hence, the existence of a linear relationship between security of supply and affordability of price may also be questioned. In order to demonstrate the validity of the claim sketched above, there is a need to take a fresh analytical path by integrating the concept of social embeddedness into the price-formation. This implies achieving insight into the nature of the valuation of resources, security perceptions, peak oil considerations and environmental concerns. Among the various other empirical observations that may be made, the likelihood that a significant demand for an elevated oil price coexists with the dynamics of supply and demand in respect of hydrocarbons should be pointed out. Moreover, oil price offers an important symbolic dimension for market and policy agents and therefore the significance of an increase in the oil price may be felt beyond physical supply flows.

2. Equilibrium versus sociological approaches in respect of prices Theories of price have been almost completely dominated by various views on the interaction between supply and demand. Classical political economy departs from the assumption that price results from an exogenously-induced supply-demand equilibrium. Thus, a large proportion of the empirical scholarship on this topic has focused on the predictive power of the behavioural pattern of rational agents in relation to price formation. In this context, a fair market price is that which is closest to the presumably objective equilibrium. The classical approach has attracted vigorous criticism on the strength of its frequent mismatching of reductionist theoretical models with empirical evidence relating to complex politico-economic systems. The equilibrium-based approaches underestimate the non-economic factors at play in both domestic and international developments (Strange, 1988). By contrast, a different ontological angle offers circumstancebased perspectives on economic processes and casts doubt on exogenously-defined agents’ interests. In this perspective, both the price equilibrium and the no-transaction costs economics become either an object of agency's meanings based on specific interest or socially-determined interactions (Wight, 2006) unevenly impacting on supply-demand dynamics. While the significance of market trends themselves should be acknowledged, the definition of markets as endogenous to social relations, perceptions and understandings is a key distinguishing feature here. Among the first theorists of social embeddedness in economic processes, Karl Polanyi questioned the validity of equilibriumbased concepts. He regarded the explanation offered by classical approaches of, among other things, deep transformations that occurred during the Industrial Revolution as being nonsensical (Polanyi, 1944). In the clarifying conditions of societal payoffs during the course of economic evolution, markets are defined as social structures and conceptualised independently from material economic structures. To put it in a slightly different way, the markets witness a specific and not unique transaction, which ‘contrary to common assumptions, does not originate in random action of exchange’ (Polanyi, 1944: 37). Therefore, Polanyi's conception assumes that markets have various functions depending on the social contexts at hand (Ankarloo, 2002). Markets form a relationship with society and therefore give rise to a number of practices and norms. Polanyi emphasises that ‘the control of the economic system by the market is of overwhelming consequence to the whole organization of society’ (Polanyi, 1944: 57). In particular, it may be noted that resources are commodified through new social and economic practices. Consequently, a price results from a contextualised web of social interactions existing beyond the supply-demand equilibrium.

The analytical framework of the ‘market society’ has influenced further theoretical constructs, including sociological institutionalism (Lie, 1991). More recently, Bourdieu (2005) has argued that social symbolism exists in any behavioural pattern and in any economic transaction. Therefore, in his view a price itself may have symbolic meaning for economic agents, such as in valuing land, luxury products and cultural goods. To emphasise the socially endogenous character of price formation, Bourdieu hypothesises a set of drivers that determine the price (Bourdieu, 2005: 197). Furthermore, this famous scholar equates markets with a relation between various forces ‘to which the different agents engaged in the field contribute to varying degrees through the modifications they manage to impose upon’ (Bourdieu, 2005: 204). In this context, the very term ‘fair pricing’ gains a symbolic, even normative, dimension contextualised within agents’ varied interests at hand. Making a theoretical account of these various perspectives might involve integrating human subjective interests, power relations, as well as perceptions and knowledge in respect of the formation of price. Directly observed empirical facts in international energy relations tend to demonstrate an ever-changing embeddedness impacting on the value of oil. Moreover, the petroleum price results from a variety of agency-based perceptions and interests ranging from short-term gains to global environmental considerations as well as the symbolic meanings of petroleum. In this context, the frequently mentioned producer-consumer juxtaposition becomes non certus component in the complex chain of economic interactions that take place at transnational level. In addition to that, the overall argument to the effect that oil price is not set by markets is open to question since markets by their very nature involve various levels of interaction, symbols, and power relations. However, a number of scholars still argue that the natural resource factor is the core issue in petroleum markets. Nonetheless, as discussed below in further detail, resources are valued on the basis of socio-economic trends related to price formation rather than vice versa. To give a general example that illustrates this issue, the Industrial Revolution did not first emerge in coal-rich regions, although the initial industrial development was based on that hard fossil fuels. In turn, the oil era is certainly an inherent part of the process of globalisation of economic transactions (Di Muzio, 2012). Increasingly, profits from the oil trade in stock markets involve the banking sector, traders, exchange-traded funds and price reporting agencies. Therefore, the new transnational hydrocarbon market differs from the previous ‘Seven Sisters’-dominated world as well as from cartel-based practices (Mitchell and Mitchell, 2015). Economic Sociology contribution to outlining the difference between economic structures and market institutions seems crucial to oil price analysis. Increasingly, the commodification process in oil markets shaped various trading schemes and derivative markets, including hedging and secondary markets. It has also been noted that in recent times the value of transactions in oil has exceeded the actual global production level because market practices offer various schemes that allow for the sale and purchase of a right to possess a given volume of energy in the future (Fattouh, 2011). The current price formation enlarges the gap between trade and physical flows (Fattouh, 2011; Dannreuther, 2015) and therefore creates yet further distance from resource-related and supply-demand equilibriums.

3. Understanding the oil price by distancing it from resource determinism The idea of unbalanced hydrocarbon prices is foregrounded within a theoretical model defining energy resources as an

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independent variable in socio-economic interactions. In this model, the physical volumes of deposits are supposedly assessed with precision and are furthermore considered as impacting factors for institutions. More broadly, this theoretical interpretation stems from a wider resource-determinism rooted in 18th century scholarship initiated by Malthus (1798). In the 20th century, on similar theoretical grounds, a number of observers pointed to the idea of Malthusian catastrophe in the current political economy in relation to oil depletion (Price, 1995). In the classical economic perspective, the response to the uneven distribution of resources and to the depletion problem rests on a variety of policy choices addressing the scarcity of resources. Thus both the concepts of Malthusian catastrophe and peak oil should be mitigated by technological development and explicit policy options. Although some sophisticated studies in the field represent important contributions to the field of energy economics (Bhattacharyya, 2011), most approaches still operate within resource determinism and agents’ efficacy in forging governance mechanisms in relation to resources. By contrast, the social embeddedness concept presupposes that resources become a secondary variable in the analysis. Paraphrasing Polanyi's words, society creates a structure where humans are unable to survive without using resources. Therefore, the core contradiction between these resources and economic growth came particularly to prominence in the aftermath of the Industrial Revolution. Moreover, societal perspectives in relation to resource economics have evolved over time, taking into consideration the transition from the utilitarian use of resources to various sustainable development targets (Castle, 1999). Thus, it can be argued that the oil price embodies agents’ role in changing material resource structures. In fact, futures’ price average underlies a benchmark for the evaluation of companies’ underground assets (Antill and Arnott, 2000; Bhattacharyya, 2011). Societal structures and institutions play a pivotal role in the assessment of natural resources. In market economies, such assessment is defined by the stock exchange and by the prices paid for commodities; while the past command economies used methodologies based on the geological feasibility of extracting the resources in question. Interestingly, the very notion of deposit is partly related to the way in which institutions organise the evaluation of underground resources. Hence, within commodified petroleum markets, when the oil price increases, more reserves are accounted for in terms of corporate assets; whereas when it declines underground values decrease. As a result, a higher price postpones peak oil because of the increase in commercial reserves. The reverse is also true, since expensive deposits are not economically accounted for where oil price is low, thus pre-peak oil period is shortened in time. An illustrative example of the negative impact of a low price on mid-term supply availability can be seen in respect of investment dynamics. Direct empirical observation indicates that capital expenditure increased from about USD 200 billion worldwide in 2005 to more than USD 600 billion worldwide in 2012, coinciding with a surge in oil price. Furthermore, global investment in exploration and production reached record levels of USD 682 billion in 2013 and USD 723 billion in 2014. The growth in the oil price in 2012–13 resulted in a 10% increase in capital investment. By contrast, when the oil price fell to USD 8 per barrel in 1998, investment in exploration and production also dropped to minimum levels (see Barclay (2014)). Likewise, the bankruptcies of small oil and gas producers that are currently taking place, and which result in reduction in production capacities, are often attributable to the declining oil price. Furthermore, software companies have relied heavily on selling their products to oil services and have therefore seen a decline in their share prices, thus contributing to a general decline in non-energy economic segments. By contrast, the expectation of an increase in the

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oil price gives impetus to new economic activities and to growth on the stock markets. A higher oil price therefore becomes a basis for the realisation of profits by stock markets participants (e.g. hedge funds, banks and various exchange traded funds). Furthermore, the oil price constitutes a factor that has an impact as far as alternatives to oil markets are concerned. Debates surrounding gas-to-oil price indexation demonstrate that oil remains a pivotal benchmark for many market agents in the transnational gas markets (Belyi, 2015). In a similar vein, empirical examples demonstrate that selected US biofuel technologies become more competitive when oil products are priced at more than USD 4 per gallon. On the other hand, a decline in the gasoline price to USD 2 per gallon would reduce competitiveness for most biodiesel technologies. Likewise, incentives to invest in biofuels decrease with the availability of cheaper crude oil even where there is significant biomass potential, as is the case in certain East European states. Consequently, oil price growth stimulates replacement costs for alternative energies and, vice versa, a price decline reduces the incentives to escape from the oil era. Therefore, the concept of price affordability in energy security might not reflect all societal and economic components inherent to the hydrocarbon markets. Issues of scarcity, of alternative technologies and of profits may indeed counterbalance demand for lower oil price levels. The empirical examples given above demonstrate that supplydemand dynamics cannot entirely be excluded from price analyses. In particular, the decline in the oil price in 2008–09 and in 2015–16 was provoked by overall economic stagnation. Likewise, OPEC's indirect influence on available physical supplies from time to time has had an effect on the price growth. However, price variations resulted merely from speculation on information on supply-demand trends rather than from the material dynamics themselves. It is noteworthy that observation of supply availability between 2008 and 2015 reveals a non-linearity with the annual price average (Fig. 1). Information on political events plays a pivotal role in shortterm oil price dynamics, while forecasts of future demand may impact on the behaviours of market agents in the medium term. It is worth noting that forecasts are frequently based on short-term price dynamics. Comparison of, inter alia, the two IEA forecast models of 1997 and 1999 indicates that the 1997 projection sets a price of USD 29 per barrel for 2010, while that of 1999 suggests USD 25 per barrel for the same year. This obvious discrepancy results from the low oil price recorded in 1998. This example interestingly highlights the influence of subjective societal understanding based on direct short-term observations, which is, however, susceptible to change over time. Furthermore, socially-embedded information on oil price dynamics impacts on various transnational behaviours, including investment and policy.

Fig. 1. Source: International Energy Agency, Oil Market Report, monthly data, Paris: OECD, Energy Information Administration, observation of oil price 2008–2015.

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4. Symbolism surrounding price A large part of scholarly literature straightforwardly relates the value of oil to its importance for economic development (Klare, 2008; Abdelal, 2013; Hancock and Vivoda, 2014). However, observation of historical trends suggests that the link between the socio-economic and physical dimensions of the petroleum sector are not entirely correlated. It may even appear paradoxical, from a deterministic viewpoint, that while oil's relative share in the world energy portfolio has declined from almost 50% in 1973 to 34% in 2009 (IEA, 2011), its business and political importance has increased across the world in the meantime. Moreover, the elasticity of oil price was significantly greater during the periods prior to the oil shock. Empirical data supports the proposition that in the early 1980s OECD members needed to produce 0.89 barrels of oil to achieve USD 1000 in real GDP growth. By the early 2000s, they only need to produce 0.63 barrels of oil to achieve the same USD 1000 growth (Yergin, 2006). Hence, the elasticity of the petroleum sectors in relation to economic growth has increased alongside the significance of the price for the markets and policies. This observation leads one to hypothesise that there is a non-linear link between the significance of oil supply and various political and economic considerations surrounding oil price. Recent empirical studies have demonstrated a positive 0.4 correlation ratio between oil price and stock exchange movements in the period between 2011 and 2015. Most importantly, any information on oil demand growth or decline may even have a direct effect on the values of general shareholdings and funds (Bernanke, 2016). A low price indicates a negative economic trend for traders and investors and, in turn, a high price creates further incentives for cross-sector investments engendered by a boost in share prices. Thus, the importance of the oil price derives from the value attributed to it by the market participants themselves as an indication of trading and investment opportunities. In terms of security relations, the oil price gives rise to a variety of behavioural expectations. Taking its cue from general security conceptions, analysis of energy security should take into account the vast variations that exist in respect of the interpretation of threat. Mistrust and fear are rarely permanent and are contextualised by the nature of agency itself. In turn, the concept of security has a different meaning for different agents (Friedman and Starr, 1997). Among other things, the security concerns of energy businesses regarding instability in producing states currently overweigh the risks of actual physical supply disruptions. The oil price engenders an ensemble of beliefs, which help to shape policy behaviours across the world. In particular, perceptions of power and capability have been influenced by the price. For example, Venezuela demonstrates an awareness of its own importance in its relations with developing countries by providing price discounts to developing countries. In turn, oil importers tend to exaggerate Venezuela's international capabilities. In addition, there is an ideational link between political institutions and oil revenue (Mitchell, 2011) because expectations regarding export revenues often have an institutional impact that is larger than that of the actual revenue. The resulting perception of expected profits during high oil price periods has sometimes provoked the renegotiation of contractual rights even before any tangible benefits are derived from the oil (Walde, 2008). Furthermore, links between budget income and policy outcomes are not always linear since many policies depend on the so-called domestic ‘social price’ of oil, which varies from one country to another depending on their domestic institutional structures. Thus, expected oil revenue levels may vary from one country to another but still reflect a revenue expectation, especially on the part of producing states and their societies. In turn, a downturn in price below ‘the expected level’ gives rise to a reaction on the stock exchanges mostly

provoked by risk aversion among investors and traders as regards anticipated political instability in the oil-rich parts of the world. This non-exhaustive list of examples demonstrates that the oil price gains a particular dimension in various societies which goes well beyond the supply-demand dynamics in the markets.

5. Conclusion An accurate ontology of homo sociologicus unambiguously demonstrates that oil price stems from various societal expectations not linearly linked to the resource availability and commodity physical flows. Being widely commodified, oil markets created a mismatch between trade and physical flows as well as between production and price movements. The oil price formation process is endogenous to information flows, affecting stock exchanges in general well beyond the petroleum trade itself. In turn, the oil price is a benchmark for various practices, from resource assessment to political considerations and even extending to risk assessments. As a factor that impacts on various practices, norms, indicators and benchmarks, the oil price assumes the shape of an institution in itself. Except in rare cases, the oil price has acquired greater significance despite the long-term decline in its significance in strict economic terms. Among other things, an elevated oil price contributes to postponing peak oil and stimulates stock exchanges and the growth of inter-fuel competition. By contrast, a low oil price often signifies a negative trend for market participants, generates new risk perceptions and decreases incentives for diversification from traditional fuels. In the new commodified market context, the notions of ‘affordability of price’ and of ‘price balance’ lose meaning when used in relation to the definition of energy security.

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