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Plentiful supply and weak demand drive decline in oil prices

Hydrocarbon Engineering,

According to the US Energy Information Administration (EIA), North Sea Brent crude oil prices have remained under the symbolic US$ 100/bbl level since 5 September, falling to US$ 94.13/bbl this afternoon, the lowest level in more than two years. Prices have declined almost US$ 21 (18%) from the 2014 daily peak of US$ 115/bbl on 19 June.

Prior to this decline, average monthly Brent spot prices traded with a narrow US$ 5/bbl band from US$ 107 – US$ 112/bbl for 13 consecutive months through July 2014. During this time of record low price volatility, substantial disruptions to OPEC supply were offset by increases in US production and weaker than expected non-US global demand. More recently, however, the return of Libyan oil production to the market, combined with the weakening outlook for global oil demand, has put downward pressure on prices.

According to the EIA, the return of significant Libyan crude oil production – which has surpassed market expectations in both volume and longevity - has been an important contributor to downward pressure on Brent prices. Despite the deterioration of the security situation in Libya, with the internationally recognised government having fled the capital, crude oil production increased from 200 000 bpd in June to almost 900 000 bpd by mid-September.

The sustained increase in Libyan production over the summer weighed on an already well supplied sweet crude market in the Atlantic Basin, despite the fact that Libya’s recent production has not come close to the level of 1.65 million bpd in 2010 and 2011, prior to the Arab Spring. Over the past several years, increasing US light sweet crude production has significantly reduced light sweet crude imports to the US. Those reduced imports, which were sourced primarily from Africa, became available to replace Libyan production lost to civil war and subsequent unrest. While Libyan production was disrupted, supply and demand in the Atlantic basin was relatively balanced. However, as Libyan production has returned, and remained online, the price of Brent has fallen.

Weakening demand in Europe and Asia in also putting downward pressure on Brent price, the EIA highlights. Economic growth in 2014 outside of the US has been slow. China, the largest contributor to forecast increases in global petroleum demand this year, reported that industrial production has risen at the slowest pace since 2008. Further, Chinese oil demand earlier this year appears to have been supported by the purchase of strategic crude oil stocks rather than by oil use related to economic growth. In Europe, The OECD has reduced expectations for economic growth through 2015 after data showed second quarter 2014 GDP contracted in Germany and Italy and stagnated in France. In addition to the weaker economy, which has been the primary factor weighing on crude demand, European refineries are facing increased competition from US and Russian refineries, causing them to reduce utilisation rates and demand for Brent crude.

Near term seasonal market conditions are also affecting crude demand, as substantial refinery turnarounds in the US, Europe and Asia take place in September and October, reducing demand for crude. The International Energy Agency (IEA) expects global refinery crude inputs to decline by 1.4 million bpd in September and an additional 1 million bpd in October before recovering in November and December.

The combination of added Libyan production, weakening global economic conditions, and seasonally low demand, each significant in its own right, has caused Brent prices to decline below the narrow band which it has traded and has helped push near term prices below longer term prices (contango), which typically specifies weak near term market fundamentals, encouraging inventory builds.

EIA explains that there are many factors that could alter the current oil market landscape. Seasonal refinery maintenance should be completed before the end of the year and, as a result, demand for crude should increase. On the supply side, there remain significant geopolitical risks, including heightened tensions, and in some cases open warfare, in key producing regions. In addition, Saudi Arabia, which recently cut production by 400 000 bpd, could make further production cuts. Earlier in 2014, near record Saudi production had helped offset high levels of OPEC supply disruptions, but the return of significant Libyan production partially alleviates the need for those barrels. Additionally, the end of Saudi peak seasonal demand for summer power generation frees up crude that was previously being used domestically, lowering the impact of reduced production on Saudi crude exports.

Adapted from a press release by Emma McAleavey

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