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Global oil markets and oil prices

Hydrocarbon Engineering,

The Institute for Energy Research (IER) has highlighted that there have been many ups and downs in the oil market over the last decade that have caused oil prices to either escalate or drop. Of particular note is the oil price drop in 2008 from a price of US$ 146/bbl in just 6 months, a price decline of over 75%. The current price decline, which has caught forecasters by surprise, is much less – closer to 25% - but has ramifications throughout the oil producing and consuming world.

Reasons for the decline

According to the IER, over the past three years high oil price have generated interest in oil production in areas previously thought too expensive to explore such as the Arctic and East Africa. With that, technological breakthroughs in oil and gas extraction and infrastructure have made the development of unconventional oil resources possible in areas that were though too high cost, or too high risk, or too far away from established markets.

More specifically, global oil production has been on the rise, particularly in North America. Due to the shale oil renaissance in the US from hydraulic fracturing and directional drilling technology, oil production has increased by 71% from average 2008 volumes to the latest production data collected by the EIA for July 2014. Likewise in Canada, oil production driven largely by oilsands, has increased by 26% from average 2008 production volumes to the latest production data reported by EIA for June 2014. Further, Russia has been setting records for oil production, producing 10.5 million bpd on average for 2013, 7.5% higher than its average production for 2008. Further, Libya, Nigeria, and Iraq have unexpectedly resumed their oil production.

In Libya, fighting and protests have curtailed production. The country is now working to sustain its production, which is averaging 900 000 bpd of oil for October – 15% higher than September. In Nigeria, oil production is often disrupted by unrest in the Niger River Delta, the country’s main oil producing region. In August, however, Nigerian oil production reached 2.3 million bpd – the most since January 2006. Its production gain in August of 380 000 bpd was the biggest one month gain since 1989. Iraq’s oil production hit its highest level in 35 years in February at 3.6 million bpd, but has since fluctuated because of logistical constraints and political turmoil. In July, its oil production dropped to 3.1 million bpd, but even this level is above what it had been producing for decades, according to EIA data.

IER highlights that added to the increasing oil supply is shrinking demand. Last month, the International Energy Agency (IEA) cut its global oil demand growth for 2014 and 2015 by 0.9 million bpd and 1.2 million bpd, respectively, because of a slowdown in demand growth in the second quarter of 2014 and a weaker outlook for Europe and China. Oil demand has stagnated or risen less than expected across Europe, Japan, China and much of the emerging world. A number of factors (e.g. slow economic growth, increased energy efficiency) have influenced oil demand in these countries.

According to the EIA, Europe’s oil demand has been declining since 2006. Europe’s oil consumption levels are at their lowest since the early 1990s. Between 2008 and 2013, oil consumption in Europe dropped by 11% due to a bleak economic outlook, increasing energy efficiency and a switch to alternative forms of energy. Further, the International Monetary Fund just downgraded Europe’s growth to less than 1%.

In Japan, the combination of a declining, ageing population and improved efficiency have cut Japan’s oil consumption by 15% between 2005 and 2013, IER explains. Imports of crude are falling, with OPEC taking much of the supply reduction. By March 2014, Japan’s total refining capacity had dropped to its lowest level since 1970 – just below 4 million bpd, a decline of approximately 1 million bpd (20%) from 2010. Further, Japan has decided to restart some of its nuclear reactors, which is expected to reduce demand for fuel oil in the power sector even more in the future.

China’s GDP growth in the third quarter of this year dropped 7.3%, its weakest rate in five years. China’s growth in oil demand has also been declining, increasing only 1.8% in the first nine months of this year, down from demand growth of 6.7% in 2011, 3.4% in 2012, and 2.5% in 2013. Despite China’s economy and oil demand growth being down, the country is taking advantage of the oil price drop by building its commercial inventories and filling its strategic petroleum reserve with less expensive oil imports.

Stopping the oil price slide

According to the IER, Saudi Arabia tried and failed to stop the price slide in August by cutting its oil production by 400 000 bpd. Having been unsuccessful, it has now decided to maintain its market share, accepting a near term loss in revenue over the next two years due to a world oil price below the breakeven price needed for balancing the national budget. By accepting the lower oil price and seeking to maintain market share, IER holds that the Saudis hope to slow or halt unconventional oil production in the US and Canada, to hurt its adversaries (Iran and Iraq) and to hinder Russia’s ability to fund the Assad regime in Syria.

Saudi Arabia is not likely to contain US shale oil production by letting oil prices drop to US$ 80/bbl for a year or two. Industry experts believe that oil prices would need to fall at least another US$ 20/bbl to affect the oil boom in the US. For instance, oil drilling in Texas’ Eagle Ford Shale would remain economic to drill at an oil price of US$ 53 – US$ 65/bbl and in North Dakota’s Bakken Shale at an oil price of US$ 60 – US$ 75. Some North Dakota producers indicated that their cheaper wells are profitable to produce at US$ 25/bbl and their higher cost wells are profitable at US$ 45/bbl because some of their losses would be protected under the federal tax code. At these lower oil prices, these companies may not drill new wells, but they can survive producing from their existing wells.

Adapted from a report by Emma McAleavey.

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