Oil’s Not Well – The Good, the Bad & the Ugly
“Brent crude oil falls below $60/bbl for first time since 2009”
These kinds of headlines are rampant in today’s economy. Ever since the oil price
mayhem began in mid 2014 the price of oil since then has fallen more than 25%, now
to $60 a barrel making the world economy wonder whether the liquid gold is losing
its sheen. Oil price have hit an all-time low, creating long-faced problems for many if
not to all the economies already battling multiple headwinds. If the price remains at
this level, it will definitely have imperative implications not necessarily bad, but not
good as well, as if the price falls further (as seems likely) the consequences on some
oil producing nations could be dramatic.
FALLING OIL PRICES
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We had it coming. Much of it has been blamed on the geopolitical crisis, which is
apparently responsible for hemorrhaging of oil prices. However the truth of the matter
is that it is more of a world economic issue than just a geopolitical one. Here’s why!
Firstly, the seeds of soaring oil prices today were planted way back in 2008. There’s
an old wall street adage - when everybody gets to one side of the boat, it usually tips
over - To prop up the world economy after the global financial meltdown, central
banks of literally every nation dramatically cut interest rates and printed trillions of
dollars worth of new currency via quantitative easing programs. Extremely
stimulative monetary environments increase the desirability and greed for hard assets
such as oil because they are a hedge against currency debasement and the associated
risk of inflation. For the past half-decade, institutional investors have clamored into
the crude oil market, causing prices to soar 140 percent, thus creating a new bubble in
the market. Secondly, due to US oil boom through fracking and horizontal drilling,
there has been a significant rise in the supply of shale oil thus cutting US oil imports.
As the world largest oil consumer, the United States’ oil boom has significantly
decreased the country’s reliance on foreign sources of oil, which is one of the main
reasons why global oil prices have remained relatively flat for the past several years.
Thirdly, the geopolitical tensions - Insurgency in Iraq since Islamic State in Iraq and
Syria (or ISIS) became a threat to supplies from giant oil fields, Ukraine conflict
involving Russia – a major supplier of energy to the world and Israel-Gaza conflict –
a region that is home to the world’s largest crude oil deposits and supplies. All of
these events kept the oil markets on edge, so the kicker is what exactly has changed?
Why are crude oil prices down from the highs in June 2014? The answer to this is that
the production is starting up again in many countries irrespective of the low demand
in Europe and all of Asia. Libya’s oil production plunged by over 80% from 4.3
million barrels a day and an eventual resolution from the current protests that have
shutdown pipeline and protests could double production to 5 million barrels a day.
Iraq, which has the world’s fifth largest proven oil reserves reached production level
which is at 30 year high as the oil industry rebuilds after the war and decades of
underinvestment. Iran, a country where economic sanctions were placed due to
nuclear programs is on it’s way to strike a deal so that it can boost exports, this could
mean 1 million more barrels of oil per day could enter the market. Venezuela despite
its profuse political predicaments expects 250,000 more barrels of oil per day aided
by European countries that are intervening to develop Venezuela Perla oil field.
Fourthly, growing fiscal deficits in OPEC countries is making it difficult for them to
cut oil production and lastly, the global oil demand in Asia is tepid and economic
outlook of Eurozone seems bleary.
US SHALE GAS PRODUCTION VS CRUDE OIL PRODUCTION
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MISMATCH IN OIL’S DEMAND AND SUPPLY
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The falling prices could prove to be an egg in one’s beer when it comes to United
States, Europe, Asia and other oil importing nations. Oil importers are set to benefit
most from the price drop. They will save on their energy bills, savings of which could
be spent on goods and services that can fuel economic growth. The U.S. economy will
receive an outsized benefit from lower oil prices since it is the world's largest oil
consumer. For many people, it will offer a nice economic boost: cheaper oil means
lower gasoline prices — which have fallen to $2.51 per gallon, the lowest in five
years thus implying higher real incomes for American consumers. Many of Europe's
economies are net importers of oil, so lower prices are likely to give a welcome to
growth. Cheaper energy reduces costs for industry and puts more money in
consumers' pockets that will be particularly be useful in the 18-nation eurozone,
where unemployment is high. In Asia, the impact is varied. The importers in China
are playing it smart where they are waiting until the oil gets even cheaper and are
delaying purchases purposely. Cheaper fuel would ease financial pressure on
manufacturers and small businesses. The higher fuel prices triggered street protests in
Indonesia, so the latest fall in crude prices may help ease tensions. Malaysia is among
the few oil-exporting nations in Asia, so the drop is hurting its coffers. When it comes
to India, the fall in Brent crude oil price is definitely a boon since the country is
dependent on imported crude for its needs. More specifically it spells good news for
PSU’s some of whom continue to share the subsidy burden due to under recoveries.
Companies like HPCL, Bharat Petroleum (BPCL) and Indian Oil stand to gain the
most, however oil production business of upstream companies will be impacted due to
lower crude realizations.
But where there is a yin, there is a yang. The big losers from falling oil prices include
Venezuela, Iran and Russia. These countries are heavily dependent on their oil
revenue to support their government spending and even if the crude jumps up to $75$80 a barrel, these countries will have difficulty in financing their populist
programmes. Oil and natural gas make about 60% of Russia’s export earnings and if
the current oil and it’s currency acrobats continue, President Vladimir Putin will no
longer be able to maintain the transfer programmes. Russian central bank said that it
expects the country’s economy to contract 4.5%in 2015 if the oil prices fall further.
There's no question that Saudi Arabia, the world's largest crude producer, will suffer
financially from cheap oil. If oil stays at around $60 per barrel next year, the
government will run a deficit equal to 14 percent of GDP. Iran’s predicament is that
it needs oil prices well north of $100 per barrel to balance its budget, especially since
Western sanctions have made it much harder to export crude. If oil prices keep
falling, the Iranian government may need to make up revenues elsewhere. There's
growing concern that the oil crash could cause Venezuela, another major oil producer,
to default. The nation's economy, which is heavily dependent on oil revenue, is set to
shrink some 3 percent this year and inflation is rampant.
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So does one get a déjà vu of the 1970’s and 80’s oil glut? Will the world float in this
glut of oil temporarily and if yes, then for how long? These are some questions to
which the markets would want an answer straightway. The price of oil at any point of
time depends on the market participant’s expectations about future demand and
supply and the beauty of dealing with a commodity like oil is that oil producers can
keep supply off market if they think that’s its price will rise later or they can put extra
supply on the market if they think price will fall. Today the market expectations are
reflecting lower future demand and increased future supply but it seems that the
economists and the oil producing nations have forgotten the basics of the law of
supply and demand - where OPEC is adamant to increase production. For a quick
recovery you need steroids and if steroids are being withdrawn then you are back to
basics. So I will stick my neck out and say that in short term Crude oil prices is in a
free fall, however if history is any indication, oil prices will eventually rise again, thus
for medium to long term perspective, the meltdown of oil prices like all bad things
isn’t going to last forever given the oil exporting nations make a bold move to stanch
the bleeding by keeping a check on the demand and supply of oil.
References:
1. Breakout Nations Book – Ruchir Sharma
2. What’s behind the plunge in oil – Mike Shedlock
3. Cheaper oil – Winners and Losers – The Economists
4. Soft Crude is Good and Bad News – Ujjwal Jauhari (BS)
5. OPEC stands pushes Brent to 5 Year Low – Reuters
6. Where now for Global Growth – Suman Bery
7. It isn’t the oil that is causing slump, its QE – Clem Chambers (Forbes)
8. Why crude oil prices have been falling lately – Alex Chamberline