Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

“Baseload” is a loaded term these days.

Prior to this, it was merely meaningless outside of utility circles. Baseload refers to a minimum level of demand for electricity and the types of power plants that tend to stay switched on most of the time to supply it. These have historically been nuclear or coal-fired plants, because their running costs were low.

In recent years, though, they’ve been supplanted in many cases by natural-gas plants and renewables, which also tend to reduce power prices overall. The Department of Energy lately is very into pushing market changes that support those old “baseload” plants – which just happen to either burn coal or employ lots of people.

Yet it isn't clear that “baseload” means quite the same as it once did in a power market that has largely stopped growing and can now mix a variety of fuel sources, demand management and, increasingly, battery storage to balance the market.

In a speech given in Oxford this week, OPEC’s secretary-general mentioned “baseload” -- but in reference to oil.

Like coal and nuclear plants, OPEC is struggling mightily to adapt to new circumstances. OPEC hasn’t been displaced from the oil market; its share of global demand still hovers around the 40 percent mark.

40 Is The New 40
OPEC's share of the global oil market has slipped since 2008 but remains around 40 percent
Source: Energy Information Administration
Note: Data for 2017 and 2018 are projections.

But its power to set prices has diminished as competitors have muscled in; chief among them U.S. shale. While the U.S. only supplies about 14 percent of the world’s oil consumption, its share of marginal growth in that consumption has surged:

The Switch
Since 2008, the U.S. has emerged as a big source of incremental oil production
Source: Energy Information Administration
Note: Annual change in oil production for each region. Data for 2017 and 2018 are projections.

And shale is a tricky beast for OPEC. It gets developed quickly, and its costs have been falling as frackers learn by doing. Little wonder that, while investment in other sources of oil struggles to recover, it has started recovering in the onshore U.S.

This, indeed, was Secretary-General Mohammad Sanusi Barkindo’s point. As more dollars target “short-cycle” resources (shale), longer-cycle, conventional oil projects are being shelved. The latter constitute the “baseload” supply Barkindo warns will be missed in years to come, leading to volatile markets.

This argument about the potential for a shortfall is valid. But OPEC has a credibility problem on this particular point.

It’s safe to assume OPEC sees itself as an important part of that trusty baseload. And it’s true that countries such as Saudi Arabia and Iraq possess the lowest-cost barrels in the world.

Yet OPEC's ability to function properly as a "baseload" supplier is compromised by the fact that, while the cost at the wellhead in many member states might be low, each barrel often also must support a lot of overhead – namely, the cost of running many of these oil-dependent economies.

Saudi Arabia’s cash cost per barrel is perhaps $20 a barrel or less, but the price required to balance the government’s books is more like $98, according to RBC Capital Markets estimates. This structural burden dictates a policy of trying to artificially lift prices by holding supply offline, rather than just producing as much as possible to supply the “baseload.”

OPEC’s record on reliability is also compromised. Like many other producers, the oil-export group was caught out by the surge in Chinese demand in the first decade of the century. After the 2008 crash, oil rebounded again partly because disruptions in OPEC members such as Libya and Nigeria took millions of barrels a day of supply offline.

Off Base
Unplanned production outages in OPEC members such as Libya and Nigeria spiked after 2010, sending oil prices back above $100 a barrel
Source: Energy Information Administration

Luckily, those short-cycle types in U.S. shale stepped in to fill the gap, spurred by triple-digit prices.

Come late 2014, Saudi Arabia was spooked enough to lead OPEC in an effort to reduce oil prices to a level that would choke off competitors. But shale producers proved more resilient than expected, cutting costs and thereby keeping oil prices down. In fact, the producers who really suffered were the ones developing those long-cycle, long-life resources like deepwater fields and Canadian oil sands – the supposed baseload, in other words.

There is no “baseload” oil as such in today's environment. There are lower-cost producers, mid-cost producers and higher-cost producers.

And then there’s that peculiar group that seems low-cost but actually needs pretty high prices to survive -- prices that are getting harder to realize in a changing energy market. America's baseload plants can sympathize. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net