Skip to main content

Turbulence in the oil market

Hydrocarbon Engineering,


According to the Brookings Institution, the sharp decline in world oil prices during the last half of this year has become the defining economic event of 2014. It has been hailed as a timely stimulus to global demand because it adds to the purchasing power of consumers. Lower gas prices have already strengthened the US expansion and supported still fragile recoveries in much of Europe, Japan and the emerging economies. These demand side effects are still growing, but they are only the most immediate impacts. Depending on how the tumultuous events in the oil market play out, they will have important effects through many other channels, and not all these will be so desirable.

Brookings seeks to put the decrease in prices in historical perspective. No simple generalisation can explain the history of oil prices. They have responded sharply to some political and economic changes and have also remained in a fairly narrow range for extended periods. In the first postwar decades, vast new oil supplies from the Middle East kept oil prices low in the face of the great postwar industrial boom. Then in 1973, Saudi Arabia and other oil producing states of the region nationalised their oil industries and formed the OPEC cartel which constrained output enough to quadruple the world oil price to US$12/bbl. In the years since, the ability or willingness of OPEC to stabilise prices has been uneven. Prices soared after the takeover of Iran by the clerics in 1979, and then slid back during the 1980s in the face of new oil discoveries in the North Sea, Mexico and Alaska, and the drive to oil conservation in the advanced economies that slowed demand growth. The next big move came in the 2000s, as surging demand for oil from China and other developing nations drive the price from approximately US$20 at the end of the 1990s to approximately US$120/bbl in the summer of 2009. Prices crashed during the Great Recession and then promptly started back up as recovery began and China’s growth continued.

And then the new era for oil began. The introduction in 2009 of fracking for recovering oil from shale deposits reversed a long decline in North American oil production. Production grew slowly at first, and the renewed global economic expansion brought oil prices back near US$100/bbl by 2011. Prices then stayed in a narrow range for three years as growing shale production kept global supplies rising in step with global demand. But by mid 2014, what had seemed a sustainable balance was upset as shale production accelerated and Libyan oil output rose sharply from depressed levels. As Saudi Arabia appeared reluctant to reduce output to support the market, the price decline steepened. Are the recent prices approximately US$60/bbl to be the new normal?

In the race between global demand and supply, today’s lower prices will both raise consumption and restrain the growth of supply. Both will move up the short run equilibrium price, suggesting a price in the US$60s could be sustainable. But uncertainty and turbulence rather than equilibrium may characterise the oil market for some time. As Libya’s experience shows, supplies from the Middle East, including those affected by sanctions on Iran, are hard to predict. How much today’s lower prices will affect growth of supply from North America is uncertain because technology is still evolving. And it is hard to judge what OPEC policy will be going forward. In the past, Saudi Arabia has reduced its production a lot in order to support the world price. But today’s environment is different in important ways. The Middle East is more dangerous than ever and the Saudis’ interests do not include supporting the revenues of countries such as Iran and other potential adversaries. And they may not welcome giving up market share to the US. This past week, the Saudi Oil Minister remarked “Why should I cut oil production?”

As this range of outcomes and responses suggests, there could be pressure for market prices to move above or below present levels. But it seems reasonable to project oil prices settle in a range in the US$60s in assessing 2015 economic prospects, Brookings holds. The already considerable stimulus to consumer spending will grow further, helping to sustain healthy employment growth. In this environment, Brookings expects a step towards normalising interest rates by mid year.

While the economic stimulus from lower oil prices starts immediately, some of the effects through other channels take more time. The creation and expansion of the fracking industry has been an important source of high paying blue collar jobs in the US and has contributed to the economic recovery. With today’s much lower prices, the industry’s future plans are being scaled back sharply which will cut into the economy’s job growth in 2015. This consolidation will also lead to a rash of bankruptcies among the small firms that have spearheaded the fracking revolution. But those are the risk of a speculative industry. In the aggregate, oil production is not a dominant part of the US economy and the positive stimulus from lower gas prices for consumers will outweigh the negative effects on employment and GDP in 2015.

For countries such as Russia, where oil sales are a major source of budget revenues and foreign exchange reserves, the drop in oil prices creates a huge financial problem, This is already reflected in the drastic decline in the value of the ruble, and the hardship will grow in 2015. With Russia’s daily output of over 10 million bpd, the price decline since last summer has reduced oil revenues by roughly US$500 million/d. Iran and other nations whose economies are dominated by oil, such as Venezuela and Nigeria, are also greatly affected. Brookings hopes that such drastic financial hardships will improve the prospects for successful diplomacy rather than increased belligerence.


Adapted from a report by Emma McAleavey.

Read the article online at: https://www.hydrocarbonengineering.com/refining/22122014/turbulence-in-the-oil-market-1822/


 

Embed article link: (copy the HTML code below):