In the first part of the blog i highlighted to importance of Crude Oil from an end consumer point of view. In this blog i will highlight issues which concern Policy makers and Business stakeholders.
Policy makers from Oil producing and exporting countries along with Oil companies have an obvious interest in having a higher crude oil price measured both in WTI (US Oil price Index) and Brent (Rest of the world Oil Price Index). If the price of Crude Oil per Barrel ( 119.2 Litres) is above $100 it would be a huge windfall gain for them as the cost of production according to Wood Mackenzie an Energy Constancy firm, ranges from $20 to $50 depending on where its produced and the risk factor involved. The opposite is true for Oil importers and businesses depended on Oil.
Overall according to economists and Oil experts a price range of $80 – $90 per Barrel is good for both the groups. The history of crude oil prices show that its extremely sensitive to geopolitical events such as civil war, unrest etc . A reason for this is that most of the crude oil in this world are in countries with a troubled past and violent present. The Middle east, Russia, Libya, Venezuela and Nigeria are few examples of such nations. In recent times there were a series of events such as the unrest in middle east, the Ukraine crises etc which had a bad effect on Oil production and subsequently on its price.
The global financial crisis post 2008 also had a terrible effect on the Oil prices as the global demand for crude oil was subdued. One can clearly see there were several factors which were driving the crude oil prices and often they use to act as opposite forces.
Meanwhile One country was looking at all this but was slowly and patiently working on a revolution. The nation is the USA and the technological innovation was oil from Shale by the method called “Fracking”. As with any other innovation it was initially dismissed by sceptics but when the results came out everyone had to bow down before the US. It changed the world Oil order and brought US to striking distance of the crown.
But was this innovation without its share of unintended consequences. An emphatic No.
Although like any other commodity innovation it increased the supply of the product but it failed to estimate the demand of the market. A global economy recovering in the ICU with Central Bankers around had no appetite to gulp the excess oil from the US. The result was a big drop in Oil prices from a high of $120 in June 2014 to near $40 in early 2015. It had devastating economic consequences for some countries such as Russia ,Venezuela, Iran etc.
I had the notion that countries and Oil groups would respond to it by cutting production. Is that not an obvious answer in a demand supply equation? Yes absolutely but the biggest question was who would cut its Oil production and take a hit on the revenues. The Saudi’s who are the leading Oil producer of the world simply refused to cut their production. They did not want to lose market share to new players and off course cause inconvenience to others.
The result of no production cut was an Oil glut in the world waiting to be digested. As a consequence prices kept on tumbling. This became unbearable for some who had higher cost of production. The outcome led some shale producers to stop production. Some clever Investment Bankers suggested M&A to the shale players and it was well received. The shale producers were not the only target for Saudi’s, their main target was their biggest regional rival Iran which had to suffer as its only source of income (to manage a sanction state) was plummeting.
US was also taking pleasure with worsening economic situation in Russia & Venezuela, two of its rivals. It allowed Oil prices to go down so that nations are taught a lesson. Russia off course had to bear the economic sanctions as well due to the Ukraine crisis.
As of today the Oil prices have recovered significantly from its low and are now around $65 per Barrel on both the Oil indexes. The decision by OPEC to keep production levels same resulted in drop in Shale Oil production which became untenable at low price.
Analysts say the increase in Oil prices would again encourage production in US which could again bring down prices. Thus its like a see-saw scenario, Excess production results in drop in prices which leads to cut in production, which in turn starts the opposite cycle.
No one knows where the Oil price would go from here but three factors are going to have a significant influence on it in the coming days:
1. The Nuclear deal between Iran & the Western Powers – This would allow Iran to raise production significantly as sanctions on it would be phased out.
2. Increase in global demand particularly from China – China’s slowing economy was a major drag on Oil prices and its growth would have a bullish effect on Oil prices.
3. The lifting of US embargo on its Oil exports – The US last year lifted a 40 year ban on Oil exports. This would allow US Oil companies to start exporting around 700,000 barrels per day from the last quarter of 2015.
Policy makers hope a low price regime for Oil would lead to more disposal income for retail customers and hence would fuel the economy. I hope my fellow Indians had a nice year of shopping.
Its better to enjoy with higher disposal incomes, who knows when things would change !!