Thursday, March 24, 2016

This is the Current State of Oil Market Prices

Since perhaps bottoming out in February 2016 -- a period where the price of crude fell more than 70 percent from its peak -- prices have increased more than 45 percent. Many attribute this spike to three important events: first, the supply outages in Iraq, the United Arab Emirates and Nigeria; second, indications of a drop in non-OPEC production; and third, Iran’s as-yet unfulfilled pledge to flood the market with oil.

Financial Firms Weigh In on the Future of Oil Prices

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The current situation has invited additional inquiry and scrutiny. Some financial firms, including Morgan Stanley, believe that the price of oil had bottomed out and is now in the midst of recovery. The bank states, “Oil prices now seem to have bottomed, even though they are likely to stay subdued for the rest of this year before starting to move higher in 2017.”

Other organizations, such as the International Energy Agency (IEA), credit the rebound to a decrease in non-OPEC produced oil, particularly of U.S. domestic production, which reached its lowest point since December of 2009. The IEA also believes that oil prices have bottomed out and should continue to rally.

Many analysts do not agree with the assumptions and predictions of Morgan Stanley, the IEA and others, citing that increased prices will once again lead to ramp up production. “My concern is if the market surges right back to $50 a barrel…we just end up with another problem six months from now,” said one head of research at Goldman Sachs Group. “You’d be taking a lot of risk entering this market early.”

The Impact of the Commodities Market and Other Factors

An interesting trend of note is that several commodities have undergone a price spike -- copper, gold, and iron ore, cocoa, and lean hogs among them. This rise in the price of many other commodities raises another question: is the price increase a temporary benefit, a by-product from a widespread drop in commodities production? History has demonstrated that the commodities market is especially prone to overproduction following a price surge.

The answer to the oil price question may depend on other important factors. For instance, many who are bullish about oil prices don’t appear to account for the supply outages -- outages that occurred in countries that are the 6th-, 8th-, and 13th-highest producers of the world’s oil. These widespread outages almost certainly had a measurable impact on oil production and affected global oil prices to a degree.

Another important factor is the unpredictability of Iran’s oil supply. As of late February, the country was -- and still is -- adamant that it will continue ahead with aggressive production. Iran is the world’s 7th-leading producer of the world’s oil supply and is eager to reclaim its standing in the world oil market.

OPEC’s Proposed Production Freeze

The proposal put forth by some OPEC member countries to freeze production appears bleak. Any robust plan to decrease oil production was bound to be met by resistance from other member countries, and indeed it was. For one, Iran reemphasized its plans to significantly boost production despite any proposed plan.

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Saudi Arabia also doesn’t appear to be taking any measured steps to reduce or freeze output: “Saudis want the price of oil to be low so that they can knock out the Americans,” said Gal Luft, senior advisor of the United States Energy Security Council (USESC). This is a potentially significant development, as Saudi Arabia is the world’s second-leading producer of crude oil.

Luft continued with his criticism of the proposal: “The Russians want it [the price of oil] to be high. I don’t see that there is a middle ground, between those that want high and those who want lows. I think (the March 20 meeting) will be a talk for the sake of talk, but nothing concrete will come out of it.”

Furthermore, economists continue to remain apprehensive about plans to freeze production, instead stating that a reduction in oil production is the only noteworthy action to stabilize the price of oil. Such economists also believe that the recent spike in oil prices is due to rare and unforeseen circumstances, not a measured and deliberate effort to freeze production.

Stakeholder Response and Future Developments

Stakeholders in the oil market -- investors, executives, workers, and national leaders -- are traditionally quite reactionary when oil prices suddenly swing in either a positive or negative direction. All things considered, it is very difficult, if not impossible, to predict the short- and long-term trends of oil production and oil prices.

Taking into account the turbulent nature of the world’s oil politicking, the degree of difficulty in making such predictions heightens. The uncertainty surrounding Iran, Iraq, Saudi Arabia, and Russia alone are enough to warrant caution about making reactionary decisions and predictions.

Regardless of how oil prices end up fluctuating in the coming months and into 2017, stakeholders would be wise to thoroughly consider events as they unfold in oil-producing countries around the world. Such events may not only predict the sustainability of short-term oil prices, but the long-term sustainability of the entire oil market.    

Thursday, March 17, 2016

Peak Oil Theory, OPEC, and the Price of Oil

Few commodities, if any, exhibit the type of variance in price as oil does. It wasn’t that long ago that a gallon of gasoline cost about $3 in most regions of the country. Currently, the same gallon of gas is selling for about half that amount—all due to the radical fall in oil prices.

Current events, as they relate to the price of petroleum, have sparked an onslaught of questions and inquiries from a wide array of stakeholders, including investors, oil company executives, politicians, economists, and environmentalists. Many of these questions and inquiries revolve around a similar theme: what is going on, and why?

What Is Peak Oil?

The concept of peak oil is extrapolated from a theory conceptualized by the geoscientist Marion King Hubbert. Hubbert’s theory postulates that for any geographic area, petroleum production eventually reaches a peak or maximum, followed by a terminal decline.

oil tanker
The concept of peak oil has obvious economic implications. In a market economy, supply and demand are the primary price determinants: when the demand for a product increases, prices will increase. Consequently, when the supply for a product exceeds demand, prices will decrease. These basic economic models of supply and demand apply to oil to the same degree as other commodities.

Economic models of supply and demand also apply to the current dialogue taking place regarding oil prices. Proponents who apply the peak oil theory to present events cite the drastic and unprecedented drop in oil prices as a potential indication that the world has reached maximum production. In July 2008, the price for a barrel of crude oil was $145—a record number. Currently, the same amount of oil is priced at approximately $37, which amounts to about a 75 percent decrease.

Coupled with this rapid decline in price is a marked increase in supply. These developments have led some economists and other experts to hypothesize that global oil production is approaching its peak.

OPEC’s Role

The Organization of the Petroleum Exporting Countries (OPEC) accounts for 40 percent of global oil production, making it a formidable influence on global oil prices. As a result of the drastic decline in oil prices, various countries are attempting to pressure OPEC leadership into cutting production in order to increase and stabilize the market price of oil. Algeria, Ecuador, and Venezuela—all OPEC members—have called for cuts in production.

However, Saudi Arabia, the de facto leader of OPEC, has not been willing to reduce supply. Industry observers note that in late 2014, the country made the decision that it would not decrease its production to counterbalance the new supply of shale oil from North American producers.

Instead, the Saudis opted to boost production and flood the market with cheaper oil, in an attempt to squeeze out North American producers and preserve its own sizeable market share. Essentially, the Saudi government is betting that it can withstand low oil prices until the threat of shale oil has diminished. To help shore up its finances, the government issued $5 billion worth of bonds in 2015 in its first entry into the bond market in eight years. Saudi Arabia’s central bank has also withdrawn up to $70 billion from foreign asset management firms, presumably in an effort to increase liquidity.

There are signs of a shift in this strategy, however. In late February 2016, the OPEC member countries Russia, Qatar, Venezuela, and most notably, Saudi Arabia, announced a tentative plan to freeze oil production at current levels. Oil prices rose in response.

Although reducing production seems logical in the face of falling prices, it can actually be risky from an economic standpoint. Any country that agrees to decrease output is consequently sacrificing its market share of a valuable commodity, something that many nations are hesitant about.

However, many economists insist that a true reduction in oil production, not a freeze, is the only sustainable and effective measure to shore up prices.

The Price of Oil

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The rapid and persistent drop in the value of oil has attracted the attention of various stakeholders. Understandably, corporate investors, executives, and workers remain apprehensive about the market. Whether favorable conditions materialize depends upon domestic and foreign supply, along with consumer demand, which shows no sign of slowing.

On the consumer side, Americans are reveling in the low cost of gasoline at the pump and the lower cost of other petroleum products. However, the global oil industry is hurting. More than 60 smaller oil and gas producers in the US have filed for bankruptcy, and last year, profits at the major oil companies declined to the lowest in a decade. In February 2016, BP reported a loss of $3.3 billion for the fourth quarter of 2015, while Exxon Mobile announced a 58 percent decline in profits during the same period.