For the past 5 years, world oil prices have been fairly stable, averaging around $100 a barrel. However, we saw price drop precipitously in the second half of 2015. As I write this article, the US West Texas Intermediate crude (WTI) bounced back to $32 from its lowest price in the past 12 years of $29.93. Price this low was last seen in December 2003. Many are beginning to think that prices have not bottomed out yet.
The reasons for such low oil prices can be attributed to a variety of global activities – weak demand in many countries due to stagnant economic growth, surging US productions in the past few years (due to advances in hydraulic fracturing), and OPEC’s unwavering commitment to not cut production as a way to prop up oil prices. Stay on the lookout for part 2 of this blog as I take a deeper dive into the new global economics of low crude oil prices.
The US and OPEC relationship when it comes to oil has much to do with the price we are seeing today. With advances in hydraulic fracturing, the US has been taking away market share from the OPEC nations. Saudi Arabia has responded vehemently. Its strategy is to drive out higher-cost producers from the industry (most of them US based), that have boosted oil output in the US from 5m barrels a day (b/d) in 2008 to over 9 b/d this past year. Saudi Arabia also publically announced it is prepared to accept lower oil prices to hinder Iran, who announced this week it was ready to provide a potential output of approximately 3m-4m b/d. This excess supply coupled with lower global demand has pushed oil prices down to historic lows.
History has shown that when there are major geopolitical and economic events that impact global economies, they spur major crude oil price shocks, much like bank runs and market crashes. During the Arab oil embargo of 1973, sudden surges in the price of oil caused economic havoc. On the other hand, the price of oil crashed in 1986, when Saudi Arabia abandoned its role as a swing producer. This wreaked havoc across the oil & gas industry and across the globe. I witnessed first-hand while living in Singapore (at that time a major hub for oil and gas companies) how the geopolitical and economic events halfway across the world, impacted the economies of other nations. The events that increase uncertainty about future oil supplies and/or disrupt actual supply tend to drive up prices.
While prices have fallen by over 50%, the benefits to the overall economy this time are less certain. Though consumers have certainly benefitted from the low prices at the pump, the energy producers are suffering. Every major energy company is undergoing layoffs and cutbacks in spending. These cutbacks are impacting financial markets globally and if it continues to stay like this for a long time it may lead to lower consumer confidence.
How will the low crude oil price affect profitability and production that will ultimately drive global economies to respond? If the first few weeks of 2016 has been any indicator, the global market and the economies reliant on oil and gas are in for one roller coaster of a ride!