Analysis: Toil for oil prices

The global energy agenda has been dominated by the rapidly falling price of oil over the last month

There have been calls for OPEC members to cut supply, but to no avail as of yet.
There have been calls for OPEC members to cut supply, but to no avail as of yet.

The global energy agenda has been dominated by the rapidly falling price of oil over the last month, with the cost of a barrel dropping by more than $25 since summer highs, and are now hovering around 2012 lows.

Much debate has raged around the cause. Although it appears a simple case of supply outstripping demand, the actual facts behind that are more complex, taking in the US shale boom, increased production from previously politically unstable countries and a stagnant European economy.

All eyes are now trained on the forthcoming meeting of the Organisation of Petroleum Exporting Countries (OPEC) that is set to take place on 27th of November in Vienna.

There have been calls for OPEC members to cut supply, but to no avail as of yet.

Khalil Almoayed, consultant at Facts Global Energy – Dubai, told Oil&Gas Middle East, that any lasting decisions are unlikely to be taken before the summit, and that prices could fall yet further between now and then.

“The fundamental reason for the fall in prices is that oil supply is larger than oil demand,” he said
“There is no turning back, at least until the 27th of November, 2014 OPEC Ministerial Conference. This indeed is a ‘softening up’ process and prices may well slide to the $60-70 per barrel range,” he added.

Almoayed believes that should OPEC be prepared to cut output, prices could bounce back to the $90 mark, but there is a major doubt as to whether some of the member countries would be able to sustain such a fall.

Indeed, rather than cut supply, the inverse could happen, according to Dr Jan Imhof, head of global modelling at Aurora Energy Research.

“The conflict in the Middle East hasn’t impacted supply greatly, oil demand has fallen below expectations this year, and, critically, OPEC’s meeting in November may signal decreasing willingness to hold back supply,” he commented.

“The budgetary positions of a number of key members make it very difficult to decrease production in response to a falling oil price. Our analysis of the fiscal positions of a number of OPEC members makes it seem unlikely. It is more plausible that production will begin to increase to sure up the public finances. Iraq and Iranian production should climb substantially in the medium to long term.”

Aurora are one of analyst and research organisations that have been forecasting a fall in oil prices over the last 12 months, a trend that could be accelerated should Saudi Arabia choose to ramp up production, rather than make agree to reduce output.

“In the short run, a rapid drop to $70 is possible - if Saudi Arabia decides that it needs the money then all bets are off. In the long-run this isn’t an unreasonable number based on fundamentals, but it is certainly well below consensus,” Imhof states.

Badr Jafar, president of independent exploration and production company Crescent Petroleum, says that Saudi Arabia is understandably not willing to bear the brunt of cuts to production, as has been the case in the past.

“It makes sense that Saudi Arabia needs to see an overall reduction in global output in order to avoid a repeat of the situation in the first half of 1980s whereby they were left single-handedly having to make deep cuts - from 10mn barrels per days to 2.3mn barrels per day - in order to try and stabilise rapidly falling oil prices due to falling global demand,” he said.

“Today, by undercutting the market, they hope to achieve this in two ways: making it economically challenging for some of the higher cost producers, including in the US and Canada, to maintain or even increase production; and to serve as an inherent warning to other producers in advance of an OPEC meeting this month that they will all need to make production cuts together if they are to curb this bearish trend of the price of oil.”

Almoayed agrees that the burden has to be shared, saying: “Within a year, we still expect prices at the floor of $80-85 per barrel, but the burden needs to be fairly divided among all players in and out of OPEC by discipline and by market forces.”

Should that prove to be true it would suggest that the holy grail of $100 per barrel isn’t a realistic long-term target.

“In the short-term $100 per barrel is very possible – and has obviously been achieved for long periods,” said Imhof. “In the long run it feels too high – while resource quality is obviously declining, over the past half century improvement in the technology of extraction have reduced costs by close to 1% per annum. The costs of finding, extracting and delivering a barrel of oil just aren’t that high for a sufficient share of the world’s resources.”

Jafar concludes: “The Gulf will remain resilient in a low price environment because of the low cost base compared to the rest of the world, but only for the time being. Over the mid to long-term, high oil prices are required to balance budgets. If they do continue to fall, you’ll see governments having to maximise production to maintain revenues.”

“It’s an interesting situation but if you were to ask me what 2014 will be remembered for, I’d say the year when the oil boom ended, so what’s the consequence of that? It might have the potentially catastrophic effect on some mid-size oil companies, but I do think that the industry is very resilient and a potential crash will highlight the industry’s ability to manage in situations of adversity and to keep increasing output if the market so requires.”

Facts:
- $86 The price of oil per barrel as of 28th of October 2014
- $60 The lowest price one barrel of oil could slide to according to industry experts
- $100 is an unrealistic long-term target for oil producing countries. Prices are expected to stay at $80-85 within a year period.

Three things you need to know...
1- Oil prices have fallen substantially since they reached a high of around $107 in the summer, to just over $80 in the last week of October. A number of factors, including increased production from the United States and Iran and a fear of deflation in the zone of the European Union, have seen supply outstrip demand.

2- The oil price slump has led to demands for the OPEC group of companies to cut supply. At the beginning of October, Credit Suisse said cuts were necessary to shore up oil prices. A fall below $85 a barrel would mean that a number of countries’ exploration activities would become uneconomical.

3- All eyes are now on the meeting of OPEC countries that will take place on 27th of November in Vienna. However, those hoping for a cut in supply could be disappointed. Kuwait and Saudi Arabia have both made firm indication that there will be no plans for immediate cuts.

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