The 2014 Oil Price Crash Explained

OPEC Split as Oil Prices Fall Sharply

Oil prices sank again on Monday, giving consumers more of a break and causing a slit among OPEC leaders about what action should be taken, if any, to halt the slide.

The price drop has led to a near free fall in gasoline prices in the United States. On Monday, the national average price for regular gasoline was $3.20, 9 cents lower than it was a week ago and 14 cents below the price a year ago, according to the AAA motor club.

The price at the pump generally follows oil after a few days, leading energy experts to predict lower prices for the rest of the month at least.

“This is not your garden variety autumn price decline,” said Tom Kloza, chief oil analyst at GasBuddy.com, which reports fuel prices from filling stations across the country. “Clearly there is a rift in OPEC, and that means we are more likely to see a price war over the next six months. Crude oil is teetering on the brink of collapse.”

Mr. Kloza predicted that the national average for regular gasoline was headed to between $2.95 and $3.10 a gallon. The average household consumes 1,200 gallons of gasoline a year, translating into an annual savings of $120 for every 10-cent drop in the price of gasoline.

Most oil analysts say that the companies that have led the boom in drilling across North Dakota and Texas are insulated from the declines for the time being, with the break-even levels for investments around $60 a barrel — which is more than $20 below current levels.

With the number of rigs working in the United States at or near record levels, some oil executives are beginning to express concern about investment decisions next year.

In recent days several members of the Organization of the Petroleum Exporting Countries — Saudi Arabia, Kuwait, Iraq, Iran and the United Arab Emirates — have cut prices to European and Asian buyers as competition for global market share has grown fierce.

With the price of the global benchmark, Brent crude oil, falling 1.5 percent on Monday to $88.89 a barrel, many analysts said Saudi Arabia, OPEC’s dominant member, might be rethinking its strategy.

 “Saudi comments indicate that it may have shifted from a strategy of holding prices at around $100 a barrel to a focus on market share,” said Jeff A. Dietert, head of research at Simmons & Company, an independent investment bank. “That means there is not an immediate floor on oil prices.” He said he thought that Saudi Arabia was trying to slow production growth in the United States.
 Oil prices have reached levels not seen since the Middle East and North Africa turmoil began in 2011 because of an unusual combination of factors: Demand for petroleum products is declining worldwide, particularly in Europe, just as the global market is flooded with oil.
 Many energy experts say the world market, which consumes about 90 million barrels a day, has one million barrels more than it needs, although that could easily change if the Islamic State, also known as ISIS, attacked Baghdad and threatened the southern Iraqi oil fields, or if militias suddenly renewed their blockades of oil ports in Libya.
 Prices of Brent and the American benchmark, West Texas intermediate crude, have slid by 20 percent or more since early summer, when prices briefly spiked because of the Islamic State offensive in Iraq. The American benchmark dropped particularly hard over several days last week, suggesting a glut in several parts of the country, particularly West Texas, where production has been ramping up in recent years.

On the supply side, the United States shale drilling boom has been a critical factor. Domestic production has reached 8.7 million barrels a day, about a million barrels a day more than just a year ago and the highest level in nearly a quarter century. Imports from OPEC countries have been cut in half since 2008, forcing countries like Saudi Arabia and Nigeria to compete with one another in Asia, cutting their prices starting last week.

 While the United States has been pushing up production month after month, so have other major producers. Saudi Arabia increased its production by 100,000 barrels a day in September, while Libyan production has increased in recent months by more than 500,000 barrels a day.

The Libyan production increase is because of an uneasy arrangement among regional militias that control the unstable country and central oil authorities to allow exports to leave the country. That flow could be interrupted any day.

Still, in its monthly oil market report released Friday, OPEC said that its members had produced 400,000 barrels a day of crude oil more last month than in the previous month.

Venezuela has called for a special OPEC meeting to deal with the price drop, while Iranian officials have called for production cuts. But Saudi Arabia is the crucial voice in the group; OPEC is responsible for roughly a third of global production.

“If the price stabilizes around here, it’s probable the Saudis will argue to wait until the November meeting when OPEC can cut the output quotas for the first quarter of 2015,” said Michael C. Lynch, president of the Strategic Energy and Economic Research consultancy and an occasional adviser to OPEC.

On the demand side, the thirst for oil is declining in Europe, where unemployment and industrial activity is down, and Japan, where the use of oil by utilities is being replaced by natural gas and coal. Restarting Japan’s nuclear plants next year will probably cut oil demand further, according to the United States Energy Department.

Last week the Energy Department reported that oil consumption in the industrialized countries was down 200,000 barrels a day this year compared with last year. The government expects American consumption, which increased by nearly 500,000 barrels a day in 2013, to decline by 40,000 barrels a day this year.

The decline in oil prices has not yet had a measurable impact on oil production, but energy experts say long-term exploration investment planning could be affected if the price decline is steep and lasting enough. Large companies like Exxon Mobil, Royal Dutch Shell and Chevron make their investment plans years in advance, but smaller independent companies can be more sensitive to price swings.

“The shale plays in the U.S. will become noneconomic at W.T.I. of $80 or so,” said Ed Hirs, managing director of Hillhouse Resources, an oil and gas exploration company, referring to the American benchmark price, currently around $85 a barrel.

Other analysts say investments will not stop dropping in an important way until the United States benchmark falls to $70 or even $60, since drilling has become increasingly efficient because of improved technology.

Oil Prices – Decline Turned Into Collapse?

Bill Greiner , CONTRIBUTOR
I get to the heart of today’s economic and capital markets issues.

Opinions expressed by Forbes Contributors are their own.
Public investment markets are inherently volatile. Oil prices have been declining since June 7th when West Texas Intermediate was selling at $107 per barrel. Today, the same barrel of oil is selling at $66, reflecting an over-supply of oil on the world market, which has driven oil prices lower. Last Thursday, OPEC decided not to cut production, confounding expectations of a production cut. Oil prices declined by 10% following the decision.

We have been consistently stating our view that oil price weakness is a function of excess supply, rather than a problem with demand (recession, for example). It is true that much of the developed world is struggling with growth, and the emerging economy’s growth profile is contracting. But global GDP is still growing, and demand for oil is still rising – just not as rapidly as supply. Regarding the volatility of oil prices, I would rather deal with a supply issue than a lack of demand issue. Why? Oil supplies (production) can be cut fairly quickly. An oil price decline driven by a falling level of demand takes an economic contraction to “fix.” Oil prices fell on Friday of last week by 10% due to the fact that OPEC didn’t “blink” – as the market expected them to by announcing a supply “cut.”

From an economic standpoint, the oil price decline is a mixed blessing. While oil prices have declined by 38%, gasoline prices have declined by 34% over the same period of time. The decline in gasoline prices by 34% acts as a “tax cut” for most consumers, as the amount they spend on gasoline has declined significantly. The average American family spends 4% of their monthly budget on gasoline. If gasoline prices stay at these levels over the next 12 months, the 34% decline in gasoline prices will act as a direct stimulus to consumer discretionary spending, at an expected annualized level of $152 billion dollars, or 0.92% of GDP.

However, there is a downside to lower oil prices the U.S. economy will have to absorb if oil prices remain at $66 per bbl. instead of the old highs at $107 per bbl. A key driver to economic growth over the last few years has been capital spending within the new “oil patch” in the U.S. Domestic oil production has soared in the U.S. over the last few years to 9.5 million barrels per day, satisfying more than 50% of our daily demand for the slippery stuff. Oil imports have declined rather dramatically. OPEC’s decision not to cut production appears to be an attempt to drive prices lower until domestic U.S. oil production is cut.

The new drilling in the U.S., driven by newer technologies and “fracking” practices, has widely varying costs of production. Much of the production in North Dakota (in the Bakken Shale formations) can remain profitable at $50 per bbl. Production in Texas (Eagle Ford formations) also supports low “lift” costs.

 

Declining oil prices help most of the developed world. Japan, Europe and the majority of the emerging economies are net oil importers. If oil prices remain at their current levels for a reasonable period of time, overall global economic growth should benefit by 0.5% – 0.6%. Current work shows if oil prices decline by 20% from peak, and stay at that range over the next 2 years, global GDP growth should rise by an additional 1.3%, on an annual basis, from its “baseline” level.

However, we don’t expect oil prices to remain at current levels over the next two years – over that period we currently expect oil prices to rise back to the $80 per bbl. range.

Longer-Term Perspective

The current oil price decline is making headlines, and for good reason. That being said, it is productive to keep a long-term perspective regarding oil prices. The chart to the below is instructive. Oil prices bottomed in 1998 at $11 per bbl. Even with the declines we have recently seen, oil prices are still more than 500% higher than they were 16 years ago.

In the past, oil price declines such as the current decline have usually been associated with an economic recession – when demand for oil contracts. The current price decline has been driven by an increase in supply and a slowing in the growth rate of demand. The most probable outcome is for oil production to continue falling until prices firm. Eventually oil prices should start rising again.

What’s behind the drop in oil prices? Here’s what analysts have to say

by Laura Lorenzetti @lauralorenzetti OCTOBER 15, 2014, 3:34 PM EDT
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From oversupply and waning demand to economic concerns and politics — experts offer their views.
Oil prices have been in a free-fall for nearly four months, and Tuesday’s $4 plunge was the biggest drop in more than two years.

Since hitting a peak of over $107 in June, the price of West Texas Intermediate crude oil has since fallen over 24%. It dropped as far as $80 a barrel on Wednesday, the lowest since June 2012. Brent crude oil has also struggled, falling as low as $84.85 a barrel Wednesday. That’s the lowest since November 2010.

The oil price collapse, paired with gloomy global economic reports, has weighed on stocks, and commodity-correlated currencies, such as the Russian ruble, have suffered. Here’s a roundup of what analysts are saying about the energy price drop.

There’s too much supply.
The current free-fall in oil prices is drawing comparisons with the “bubble bursting” crash of 2008, although there are some key differences this time around, said Tarun Dang, managing partner with Trend-Wise Capital Management.

“While decline in demand was the key driver for the 2008 crash, the sharp drop in prices this time around is being caused by a supply glut. Continued growth in U.S. shale production and increase in non-OPEC countries oil exports have led to excess capacity,” he wrote in a note to clients.

Rising global tensions aren’t even boosting oil prices: “The impact of this increased U.S. oil production is quite immense, that unlike in the past, geopolitical tensions have been unable to push oil prices higher,” Dang wrote.

And too little demand.

What’s making the supply glut even worse? Slowing demand. The International Energy Administration lowered its crude oil demand projections for 2014 to about 200,000 barrels per day from the current 700,000 barrels per day. The IEA forecast is the lowest since 2009.

“Chinese demand seems to be softening and there are severe questions about the Eurozone’s recovery, leading the International Energy Agency to cut its outlook,” Scotiabank Economics wrote.

Total world oil demand is expect to grow at 1.05 million barrels per day this year. That’s well below the expected increase in production from non-OPEC countries alone, which is anticipated to grow by 1.68 million barrels per day in 2014, according to KAMCO research.

“Dynamics in the crude oil market are not supporting prices — to say the least,” said Scotiabank.

Economic growth concerns fuel fears.

Dragging oil demand may continue longer than many economists would like as global economies struggle to post strong recoveries, and some nations, such as Japan, substitute oil for natural gas and alternative fuel sources.

“One of the reasons for an extension in the decline was the disappointing German output that reinforced worries that global oil demand will falter,” wrote Dukascopy Bank in a note to clients.

Those fears are compounded by the International Monetary Fund’s global growth downgrade, which “reinforces the narrative of the last few weeks, meaning that demand is set to remain soft,” the bank said.

And then there’s the stronger U.S. dollar.

A stronger U.S. dollar isn’t helping prices. The dollar hit a 4-year high on Oct. 3 as measured by the Bloomberg Dollar Spot Index, which tracks the greenback against 10 global trading partners.

“Oil prices continued the downward movements during Sept-14 for the third consecutive month … as sluggish demand, ample supply and a strong U.S. dollar continued to be the key points pressuring the oil market,” KAMCO wrote to clients. “This is in addition to the pressures from the weak economic data from the world’s biggest energy consumers.”

If the U.S. dollar were to fall, oil prices would have been supported more than what the market has seen recently, Dukascopy Bank said.

OPEC won’t be coming to the rescue.

OPEC’s next meeting is scheduled for Nov. 27, and many experts are hoping the cartel will push up that date. That is looking unlikely, as is any help from OPEC to boost prices as Saudi Arabia sits quietly on the sidelines.

For most of the 21st century, Saudi Arabia has been willing to be the swing producer for the globe, helping to support oil prices. However, much of the rhetoric coming out of Riyadh indicates that the nation is not inclined to cut production or call for an early meeting, said Tom Kloza, chief oil analyst for GasBuddy.com.

“The Saudis are the Michael Jordan’s of OPEC and they don’t appear ready to take one for the team right now and cut unilaterally,” he said.

All of these factors will add up to a “very sloppy oil market,” said Kloza. “Speculation drives prices higher and is now probably driving prices lower.”

The Economist explains

Why the oil price is falling

THE oil price has fallen by more than 40% since June, when it was $115 a barrel. It is now below $70. This comes after nearly five years of stability. At a meeting in Vienna on November 27th the Organisation of Petroleum Exporting Countries, which controls nearly 40% of the world market, failed to reach agreement on production curbs, sending the price tumbling. Also hard hit are oil-exporting countries such as Russia (where the rouble has hit record lows), Nigeria, Iran and Venezuela. Why is the price of oil falling?

The oil price is partly determined by actual supply and demand, and partly by expectation. Demand for energy is closely related to economic activity. It also spikes in the winter in the northern hemisphere, and during summers in countries which use air conditioning. Supply can be affected by weather (which prevents tankers loading) and by geopolitical upsets. If producers think the price is staying high, they invest, which after a lag boosts supply. Similarly, low prices lead to an investment drought. OPEC’s decisions shape expectations: if it curbs supply sharply, it can send prices spiking. Saudi Arabia produces nearly 10m barrels a day—a third of the OPEC total.

Four things are now affecting the picture. Demand is low because of weak economic activity, increased efficiency, and a growing switch away from oil to other fuels. Second, turmoil in Iraq and Libya—two big oil producers with nearly 4m barrels a day combined—has not affected their output. The market is more sanguine about geopolitical risk. Thirdly, America has become the world’s largest oil producer. Though it does not export crude oil, it now imports much less, creating a lot of spare supply. Finally, the Saudis and their Gulf allies have decided not to sacrifice their own market share to restore the price. They could curb production sharply, but the main benefits would go to countries they detest such as Iran and Russia. Saudi Arabia can tolerate lower oil prices quite easily. It has $900 billion in reserves. Its own oil costs very little (around $5-6 per barrel) to get out of the ground.

The main effect of this is on the riskiest and most vulnerable bits of the oil industry. These include American frackers who have borrowed heavily on the expectation of continuing high prices. They also include Western oil companies with high-cost projects involving drilling in deep water or in the Arctic, or dealing with maturing and increasingly expensive fields such as the North Sea. But the greatest pain is in countries where the regimes are dependent on a high oil price to pay for costly foreign adventures and expensive social programmes. These include Russia (which is already hit by Western sanctions following its meddling in Ukraine) and Iran (which is paying to keep the Assad regime afloat in Syria). Optimists think economic pain may make these countries more amenable to international pressure. Pessimists fear that when cornered, they may lash out in desperation.