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Limited potential for oil to scale up this year

Published on 6th June, Edition 23, 2016

 

From 2010 until June 2014, world oil prices had been stable, at around $110 a barrel and since June 2014 prices have more than halved. Brent crude oil has now dipped below $50 a barrel for the first time since May 2009 and US crude is also below $48 a barrel. Oil just like any other commodity is regulated by rules of demand and supply. But there is one more solid reason that affects the price of oil is expectations.

The recent fall in the price of oil can be attributed to four major reasons — demand is low due to weak economic activities in China and all over the world in general; political upsets and conflicts in Iraq and Libya (two big oil producers with nearly 4m barrels a day combined); US has become the world’s largest oil producer after extracting oil from shale formations and Saudi Arabia has decided not to sacrifice their own market share to curb the falling prices of oil. The reasons for this change slowing demand in many countries due to dull economic growth, mixed with accelerating US production. Further that Organization of the Petroleum Exporting Countries (OPEC) is determined not to cut production as a way to accelerate prices. In this regard many experts were of the view that there is limited potential the oil prices will move higher this year.

Adding more pressure on the prices, a last week’s meeting of OPEC failed to agree a clear oil-output strategy as Iran insisted on steeply raising its own production, though Tehran’s arch-rival Saudi Arabia promised not to flood the market and sought to mend fences within the organization.

Tensions between Saudi Arabia and Iran had blighted several previous OPEC meetings, including in December 2015 when the group fell short of agreeing a formal output target for the first time in years. In a rare compromise, OPEC also decided unanimously to appoint Nigeria’s Mohammed Barkindo as its new secretary-general after years of friction over the issue.

Global oil prices have fallen drastically over the past seven months, leading to significant revenue shortfalls in many energy exporting nations, while consumers in many importing countries are likely to have to pay less to electricity to their homes and drive their cars.

Russia in pain

The falling Russian rouble and plunging oil revenue are some of President Putin’s biggest problems. Russia is one of the world’s largest oil producers, and its phenomenal interest rate rise to 17 percent in support of its troubled rouble underline how heavily its economy depends on energy revenues, with oil and gas accounting for 70 percent of export incomes. Russia loses about $2 billion in revenues for every dollar fall in the oil price. It has confirmed it will not cut production to shore up oil prices.Falling oil prices, combined with Western sanctions over Russia’s support for separatists in eastern Ukraine have hit the country hard. The government has cut its growth forecast estimating that the economy will ran into recession.

Some economists expect further measures to strength the currency. Russia’s economy is forecast to fall into recession if oil prices do not regain ground. Owing to the impact of falling oil prices and sanctions, the government had to cut spending and had to abandon a number of programs and make certain sacrifices.

Russia’s interest rate acceleration may also bring its own problems, as high rates can dampen economic growth by making it difficult for businesses to borrow and spend.

Venezuela finding way out

Venezuela is one of the world’s largest oil exporters, but due to economic turmoil it was already finding it difficult to pay its way even before the oil price started falling. Inflation is at 60 percent and the economy is on the point of recession. The need for spending cuts is very much clear, but the government faces difficult choices.

The country already has some of the world’s cheapest petrol prices – fuel subsidies cost Caracas about $12.5 billion a year. The President Maduro has ruled out subsidy cuts and higher petrol prices.

Saudi Arabia can hold on

Saudi Arabia is not expected to cut production to raise oil prices in the short term. Saudi Arabia, the world’s largest oil exporter and OPEC’s most influential member, could support global oil prices by reducing its own production, but there is little sign it wants to do this. Although Saudi Arabia may want oil prices to be around $85 in the longer term, it has a deep reserve fund of some $700 billion and so it can withstand lower prices for some time.

In terms of production and pricing of oil by Middle East producers, they are beginning to recognize the challenge of US production. If a period of lower prices were to force some higher cost producers to shut down, then Saudi Arabia might hope to pick up market share in the longer run.

It may be remembered that in the 1980s Saudi Arabia did cut production substantially in a bid to boost prices, but it had little effect and it also badly affected the Saudi economy.

 

Along with Saudi Arabia, Gulf producers such as the United Arab Emirates and Kuwait have also amassed considerable foreign currency reserves, which means that they could run deficits for several years if necessary.

Other OPEC members like Iran, Iraq and Nigeria, with greater domestic budgetary demands because of their large population sizes in relation to their oil revenues, have less room for manipulation. They have accumulated foreign currency reserves of less than $200 billion, and are already under great pressure from increased US competition.

Nigeria, which is Africa’s biggest oil producer, has seen growth in the rest of its economy but despite this it remains heavily oil-dependent. Energy sales account for up to 80 percent of all government revenue and more than 90 percent of the country’s exports.

Pumps in a California oil field over the Monterey Shale formation where gas and oil extraction using hydraulic fracturing, or fracking, is on the verge of a boom.

US domestic oil production has boomed due to fracking. The growth of oil production in North America, particularly in the US, has been staggering. US oil production levels were at their highest in almost 30 years.

It has been this growth in US energy production, where gas and oil is extracted from shale formations using hydraulic fracturing or fracking, which has been one of the main strength of lower oil prices.

Growth in the European Union remains weak by low inflation and any benefits of lower prices would be a favorable step by beleaguered governments.

China, which is set to become the largest net importer of oil, should gain from falling prices. However, lower oil prices won’t fully offset the far wider effects of a slowing economy.

Japan imports nearly all of the oil it uses. Lower prices are a joint blessing because high energy prices had helped to push inflation higher, which has been a key part of Japanese Prime Minister Shinzo Abe’s growth strategy to combat deflation.

India imports 75 percent of its oil, and analysts say falling oil prices will ease its current account deficit. At the same time, the cost of India’s fuel subsidies could fall by $2.5 billion this year. This will be only if oil prices stay low.

Wildfires in Canada’s oil-sand hub and the ongoing political strife in Nigeria buoyed prices to a nearly eight-month high, but as Canada is set to resume normal oil operations later this week, analysts are wary how long these bullish factors can last.

Recent oil history

From 1999 to mid 2008, the price of oil rose significantly. It was explained by the rising oil demand in countries like China and India. In the middle of the financial crisis of 2007–2008, the price of oil underwent a significant decrease after the record peak of US$145 it reached in July 2008. On December 23, 2008, WTI crude oil spot price fell to US$30.28 a barrel, the lowest since the financial crisis of 2007–2010 began.

The price sharply rebounded after the crisis and rose to US$82 a barrel in 2009. In July 2008 oil reached a record peak of US$145 but by February 2009 it sank beneath $40 a barrel. On 31 January 2011, the Brent price hit $100 a barrel for the first time since October 2008, on concerns about the political unrest in Egypt. For about three and half years the price largely remained in the $90–$120 range.

In the middle of 2014, price started declining due to a significant increase in oil production in USA, and declining demand in the emerging countries. The oil glut — caused by multiple factors — spurred a sharp downward spiral in the price of oil that continued through February 2016. By February 3, 2016 oil was below $30 — a drop of “almost 75 percent since mid-2014 as competing producers pumped 1-2 million barrels of crude daily exceeding demand, just as China’s economy hit lowest growth in a generation. Some analysts speculate that it may continue to drop further, perhaps as low as $18.

According to a report released on February 15, 2016 by Deloitte LLP — the audit and consulting firm — with global crude oil at near ten-year low prices, 35% of listed E&P oil and gas companies are at a high risk of bankruptcy worldwide. Indeed, bankruptcies in the oil and gas industry could surpass levels seen in the Great Recession.

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