In early October, Brent crude oil was trading as low as $92/bl – a marked drop from the $115/bl it reached in mid-June and the $105/bl to $112/bl range it has held for most of the past three years. In the midst of some serious geopolitical threats to oil supplies in the Middle East, this price plunge requires an explanation.
Just a few months ago, the International Energy Agency was forecasting a significant supply deficit of 900 000 bbl/d in the second half of this year, as it had expected global demand to surge by 1.32-million barrels a day over last year. But, since then, the global economy has taken a turn for the worse.
As the world’s top oil importer, China has an outsize influence on the world market. The Asian giant’s gross domestic product growth rate rose marginally to 7.5% in the second quarter, but this is slower than the rate of the past few years, and oil demand growth has slackened.
This is partly because of faltering economies in some of China’s main export customers – in particular, the eurozone. Oil consumption in the European Union has been declining since 2005. The countries with the steepest falls in oil consumption are the Mediterranean nations of Spain, Portugal, Italy and Greece. This is partly because of their debt crises, but it is noteworthy that all these countries are 100% dependent on imported fossil fuels – an important factor in their economic woes, since the oil price began its steep rise in the mid-2000s.
Another recent factor dampening speculators’ enthusiasm for oil is the Ebola outbreak – particularly after it reached the US. Travel restrictions could curb demand for jet fuel and harm the global economy, but probably not as much as speculators are betting on.
On the other side of the equation, oil supplies are currently ample, with US shale oil continuing to grow and some Libyan oil reaching export markets again.
The oil price fall is also partly a result of a recent surge in strength of the US dollar, value of which is inversely related to the dollar- denominated price of crude.
One of the more puzzling factors in the recent market ructions is Saudi Arabia’s announcement at the end of September that it would further trim the price at which it sells crude to customers in Asia, Europe and North America. Traders interpreted the price cuts as implying the Saudis would not be reducing output in the near future.
The common explanation for the Saudi action is that the country is protecting its market share in an oversupplied market. But that goes against historical behaviour. Traditionally, the Saudis have played the role of the world’s swing producer – limiting supply when prices fell and expanding output when prices rose too fast, threatening demand-reduction responses in oil-importing nations.
A remote possibility is that there is some behind-the-scenes geopolitical manoeuvring taking place. Some analysts allege that, in the mid-1980s, the US convinced the Saudis to flood the world with their low-cost oil and undercut the Soviet Union’s more costly oil production. The aim, apparently, was to curb Soviet oil exports, thereby undermining the Soviet economy. Could it be that similar dealing has been done in order to further weaken the Russian economy on top of the sanctions the US and Europe have imposed on Russia following the Ukrainian conflict?
Geopolitical speculations aside, how long might the oil price remain in double- digit territory?
Production cost factors suggest prices will soon rebound. The last time Brent dropped below $100/bl, oil companies working in the Canadian tar sands began to scale back operations, as they were becoming uneconomic. Some analysts estimate that the cost of fracked ‘tight oil’ in the US averages $60/bl to $80/bl, but costs might be higher for some of the lower-yielding areas, placing them in jeopardy if prices stay low.
Should lower oil prices persist owing to weak global demand, this will force oil companies to cut back on investment in exploration and production, thereby sowing the seeds of a tighter market and higher prices further down the road.
The other wild card in the deck is the security situation in the Middle East. Although the escalation of conflict in Iraq and Syria – the actions of the Islamic State and the retaliatory air strikes by the US and its allies – has yet to seriously rattle the oil market, this could easily change if Iraq’s bountiful southern oilfields are threatened.
All these dynamics underscore the complexity of the world oil market, which is a lynch pin between economic, financial, energy and geopolitical systems. The world is still addicted to oil: it provides the largest share – nearly a third – of the world’s primary energy and about 95% of transport fuels. The past few years of relatively stable oil prices have been somewhat surprising; short-term gyrations in the oil market are to be expected going forward.