Energy Transition

Why are oil prices so low?

A worker walks past a pump jack on an oil field owned by Bashneft company near the village of Nikolo-Berezovka, northwest from Ufa, Bashkortostan, January 28, 2015. New European Union sanctions against Russia could include further capital markets restrictions, making it harder for Russian companies to refinance themselves and possibly affecting Russian sovereign bonds and access to advanced technology for the oil and gas sectors, EU officials said on Wednesday.

Why oil prices are so low and expected to stay that way. Image: REUTERS/Sergei Karpukhin

Keith Breene
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Oil and Gas

Just a few years ago, the world couldn’t get enough of it. Now, everyone talks of a glut. The oil price is well and truly in the doldrums.

Since 2014, the price of oil has been on a downward trajectory which has taken the industry into territory not seen for decades.

What, on the face of it, seems like great news for the consumer is already having serious knock-on effects in the world economy. Some are positive, some are not.

How does the price compare to recent years?

In early 2016, the price of crude oil was more than 70% lower than in 2014. If you look back to the pre-financial crisis peak of 2008 the drop is even steeper.

The days when the talk was of a crisis caused by high oil prices seem to belong to a different era.

Crude oil ($ barrel)

Crude oil prices ($/ barrel)
Image: Reuters

Why have prices dropped so much?

On one level the answer could not be simpler: supply and demand. There is not enough demand for all the oil that is being produced.

Why? Well, there are many factors at play in the global market but several major issues are particularly relevant.

On the supply side, the United States has nearly doubled its domestic production over the last few years. The growth in shale oil means the foreign oil it no longer needs to import has to find a buyer elsewhere.

Weekly US field production of oil

 Weekly US field production of oil
Image: U.S Energy Information Administration

Canadian and Iraqi oil production and exports are also rising year after year and Iran’s return to the international oil market after sanctions were lifted in January is also starting to have an impact.

OPEC has not been cutting production to shore up prices, something it used to do all the time. And Russia, despite its economic problems, is managing to keep pumping at record levels.

On the demand side, the economies of Europe and developing countries are weak, China’s growth has slowed and around the world vehicles are becoming more energy-efficient.

All of which helps to explain why, despite demand continuing to rise, supply has risen even faster.

Balance of supply and demand

 Balance of supply and demand
Image: New York Times

Why is OPEC behaving differently?

Iran, Venezuela, Ecuador and Algeria have all pressed OPEC to cut production to firm up prices.

At a meeting in Doha, Qatar in April, major oil producers including OPEC members and Russia met as part of efforts to agree to an output freeze, but the talks ended with no deal. Saudi Arabia had called for Iran to be part of the agreement, but Tehran refused.

Agreement given such differing national interests seems unlikely in the near future.

With increased competition Saudi Arabia may be happy to keep prices low for a while to make it uneconomical for other countries to develop further oil production.

Some analysts think OPEC will never return to its production-cutting ways.

How long will this go on for?

There seems to be little belief that prices will rise significantly in the near future.

A number of potential catalysts could drive oil yet lower. Some analysts have said that $10 a barrel is now not out of the question. Others expect to see a moderate recovery over the next few years.

However, most analysts think it will be years before oil returns to $90 or $100 a barrel, a price that was seen as the norm over the last decade.

With lower oil prices, many new oil projects are being cancelled or postponed, which is likely to reduce some of the over-production as older and more expensive projects close down.

The effect of this may be counter-balanced in the short term by the massive amount of surplus oil which is currently being stored around the world. This effectively adds even more supply to the future market.

Who are the winners?

The most obvious beneficiaries are drivers paying far lower petrol prices. Diesel, heating oil and natural gas prices have also fallen sharply around the world.

Consumer goods are also becoming cheaper as manufacturing and transport costs fall. And oil importing nations benefit from having to spend less fulfilling their energy needs.

Who are the losers?

Oil-producing countries are the biggest losers.

Venezuela, Nigeria, Ecuador, Brazil and Russia are just a few petro-states that are suffering economic turbulence.

Gulf states have also come under strain, with Saudi Arabia unveiling a record budget deficit of 367bn riyals (£67bn) for last year.

The oil companies are experiencing tough times. Chevron, Royal Dutch Shell and BP have all announced cuts to their payrolls to save cash. Exxon has reported record low quarterly profits, and was recently stripped of its top AAA credit rating.

Many smaller independent oil and gas producers are going out of business altogether.

If oil prices drop further there are likely to be much deeper cutbacks in production as oil companies pull out of existing projects and cancel more future construction. The impact on the long-term oil market is likely to be significant.

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