Shiva Hari Subedi, analyst contest
The crude oil price was around $110 per barrel from 2010 until mid of 2014 but now oil is currently trading around $36 per barrel. Just few weeks ago, it even fell below $30 per barrel and was trading around $27 per barrel as a result of Saudi Arabia"s strategy to protect their market share by eliminating Non-OPEC oil producers which have high cost of production and by weak demand in many countries. Moreover, there is slowdown in China. Recently, International Sanctions over Iran"s nuclear program were lifted and the Iranian government began supplying oil in the market.
China is the second biggest economy, the largest oil importer and biggest energy consumer in the world. In 2015, the China"s growth slowed to its lowest in 25 years and its debts keep on rising, with its economy growing at 6.8 percent in the fourth quarter of 2015. There is manufacturing recession in China. For February 2016, the China"s official manufacturing Purchasing Managers" Index (PMI) came at 49.0; below forecasts for 49.3 and January"s reading was 49.4. The PMI number below 50 means that there is fall in manufacturing activities in the country and above 50 represents means expansion in manufacturing activities. In the past, the Chinese economy was based on the manufacturing industry but now manufacturing makes about 40 percent of their gross domestic product (GDP) and the service sector contributed to about 50.5 percent of the GDP in 2015. Right now, the China is in a transitional period. It is shifting from manufacturing based industry to service based industry. These ongoing slow down, debts and recession problems have a direct negative impact on oil demand, therefore it helps to keep oil price lower. It"s all about supply and demand that is driving oil price in the market.
OPEC (Organization of the Petroleum Exporting Countries) produce about 40 percent of the world"s crude oil and OPEC"s oil exports represent about 60 percent of the total petroleum traded internationally. Saudi Arabia is the largest oil exporter in the world and second biggest oil producer. Saudi Arabia has been over-supplying the oil market in order to decrease the price and the low oil price has hit non-OPEC producers, such as those of US shale, harder. Now the US oil rig count is down nearly 75 percent from its peak of 1,609 in October 2014 before oil prices start falling. Baker Hughes data shows that the number of rigs drilling for oil in the US dropped by 26 in the third week of Feb 2016, leaving just 413 rigs active. It is expected that US rig count will continue to fall until mid of 2016 due to the low oil price which is currently trading at above $35 per barrel. US oil producers have been suffering hard due to low oil prices and in January and February of 2016, drillers have mothballed 123 oil rigs. This US rig count is at the lowest level since April 30, 1990 when there were 494 active rigs.
Saudi Arabia is also known as the Reserve Bank of oil. Crude oil was trading from $100 per barrel to $27 per barrel in just 18 months. US Shale has a high cost of production. These small and mid US shale companies do not have ability to handle low oil price for a long time as these companies have borrowed huge amount of cash when crude oil price was high and interest rates were low. During that time everybody was exploring oil and other commodities. But now the situation is different. Interest rates are rising and commodities are at a low price. In 2015 due to low crude oil price, 42 North American drillers had filed for bankruptcy and it is expected that it will get worse this year.
But Saudi Arabia can survive months with low oil prices because it has somewhere around $624 billion reserve assets as of December 2015. In 2015, the Saudi Arabia"s up to 73 percent of government revenue came from oil and the Saudi government is expecting the 2016 budget deficit to be at 326 billion riyals ($87 billion) from 367 billion in 2015 due to low oil price driven by oversupply. Spending, which reached 975 billion riyals this year, is projected to drop to 840 billion. Revenue is forecast to decline to 513.8 billion riyals from 608 billion riyals. The collapse in oil prices has been hitting government revenue hard, forcing officials to draw on reserves and issue bonds for the first time in nearly a decade.
The crude oil production of Saudi Arabia"s increased to 10230 BBL/D/1K in January 2016 from 10144 BBL/D/1K in December of 2015. From 1973 to 2016 the average crude oil production of Saudi Arabia is 7967.38 BBL/D/1K but in June 2015 it reached highest of 10564 BBL/D/1K and lowest in August of 1985 at 2340 BBL/D/1K. This over production of crude oil by Saudi Arabia is driving the low oil price and it is not only the factor that is helping to keep oil price low, but there is less demand for oil in many countries and global growth is weak at present. In 1985-1986 oil prices collapsed after a sharp increase in oil price in the 1970s because Saudi Arabia decided to expand its market share in December 1985. Then oil price fall about 61 percent, from $24.68 to $9.62 per barrel. This is exactly what is happening right now on the oil market. Saudi Arabia wants to increase its market share after the collapse of US shale companies. Global oil supply dropped 0.2 mb/d to 96.5mb/d last month.
Recently, the oil price is trading higher after Saudi Arabia and Russia agreed to freeze oil production with the intention of supporting the oil price. The reason behind good moves in oil within the last few weeks is that the production volume has come down in the US and this is the first time that crude oil price has started getting higher and investors are expecting higher oil prices now, but this is a fake move. The oil price rises from around $27 per barrel to around $36 per barrel in a few weeks. But the oil price will fall down again because total US Shale production has started falling down, but it is not falling fast enough and US Shale will again re-start production if oil prices reach above $40 which is not good news for Saudi Arabia"s strategy to protect its market share, and It will make immediate turn back on US Shale production. If OPEC decides to decrease oil production now then oil importer countries will increase their production and this will mean a loss of their niche market. Moreover, Iran"s international sanctions were lifted in January 2015 which included an end to an EU embargo on imports of Iranian oil. It is estimated that Iran will add 500,000 barrels of oil per day by the end of 2016 which means increasing oil supply to the market.
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All though Russian Energy Minister Alexandar Novak had said that a meeting between OPEC and non-OPEC major oil producers about freezing oil production in order to raise oil price could take place between March 20 and April 1, 2016.
But, according to IEA (International Energy Agency) – "With major doubts around these five drivers of recent relative price strength we are left with our revised supply/demand balance. In this report we suggest that the surplus of supply over demand in the early part of 2016 is even greater than we said in last month"s OMR. On the assumption – perhaps optimistic – that OPEC crude production is flat at 32.7 mb/d in Q116 there is an implied stock build of 2 mb/d followed by a 1.5 mb/d build in Q216. Supply and demand data for the second half of the year suggests more stock building, this time by 0.3 mb/d. If these numbers prove to be accurate, and with the market already awash in oil, it is very hard to see how oil prices can rise significantly in the short term. In these conditions the short term risk to the downside has increased."
The outcome of OPEC and Non-OPEC meeting will be nothing and OPEC will not cut their production. If OPEC decided to cut their production – which is very unlikely to happen: major problems lie with 50 years old tanker-tracking system when determining the supply of oil. There are group of small companies whose main job is to count the number of tankers leaving ports. During the tracking time these companies make their own guess about how much crude oil is being carried by measuring the depth of vessels in the sea. But the main problem is that it does not show output or increase in output which is most important and this problem gets more complex when oil is supplied through pipelines. Russia uses pipelines for oil supply and it counts around 30 percent of its total supply. The pipe supply is measured by independent groups which use infra-red photography that gives an approximate output. Therefore, oil price will go down below $30 per barrel after this meeting OPEC and non-OPEC meeting is over in March 2016.
After analyzing all the market information, it is expected that crude oil price will stay low for at least next six months around $30 or below $30 per barrel. In short term, there is only one factor that can drive oil price higher that is geopolitical reason of Syrian civil war if Saudi Arabia and Iran decide to take part in Syrian civil war with military forces which is unlikely to happen but not impossible. In long term, the oil price will be higher after US Shale production has fallen enough, more US Shale companies need to be declared bankrupt and Saudi Arabia"s strategy to protect market share is achieved. In long term, It is expected that the crude oil will be above $60 per barrel because at $40 nobody makes profit and oil price for Middle East needs to be around $80 per barrel. It is really hard to say exactly when the oil price will start getting higher because it is all dependent upon how long US Shale can withstand lower prices and when they will declare bankruptcy and stop production.
But if 2016-2017 a commodity recession comes true then crude oil will be at $20 or $15 per barrel which is possible because there is slowdown in China, Japan is in recession, half of Europe is in recession, European banks are under pressure while EU is dependent upon banking sectors and banks around the world are adopting negative interest rates. Although the recent US unemployment rate below 5 percent, in February 2016 the US added 242k new jobs but wages growth is at 2.2%, estimated 2.5%: the lowest since July 2015 and average hourly earnings falling by 0.1% MoM. Moreover, there is low inflation in Eurozone. Mario Draghi at ECB has been using monetary policies to achieve 2 percent inflation target but at present annual inflation rate is 0.1% below its target level.