The oil price collapsed last Monday after an acrimonious meeting of the Opec exporters’ cartel. Having been above $105 a barrel in June last year, US crude fell to $37.65 – a 64pc drop in just 18 months, and to the lowest price since the worst of the global financial crisis in February 2009.
It then plunged again last Thursday, moving below $37, amid further evidence that Opec’s 12 member states, from the mighty Saudi Arabia to tiny Ecuador, are cracking up. After staying well above $40 a barrel for months, crude has now crashed decisively through. That psychological lower threshold having been breached, there is now widespread speculation that crude could tumble much further – maybe even as low as $20.
I don’t buy that. Just as fast as crudes prices have fallen over the past year or so, they could easily spring back again. One reason is that these recent drops reflect supply patterns that are driven almost entirely by geo-politics – and geo-politics can quickly shift.
It’s also axiomatically true that a collapse of the crude price, from an average of $94 a barrel in 2014 to $49 so far this year, entirely contradicts the long-term fundamentals of ever-rising global oil demand and the geological and logistic constraints on future increases in supply.
Last November, Saudi Arabia decided that Opec would not cut its export quota in the face of falling prices. The idea was to keep pumping like billy-o to drive prices even lower, knocking upstart and relatively high-cost US shale producers out of the market. Photo: Alamy
Opec’s strategy has worked in the sense that we now have a short-term supply glut which, together with a slowing Chinese economy and expectations that Iranian oil could soon hit global markets, has resulted in big price falls.
It’s also caused a slowdown in the rate of growth of American crude production, which rose 16pc to 8.7m barrels a day in 2014, but is this year on course to grow just 7pc to 9.3m barrels daily, as many shale producers have indeed suffered from low prices and been forced to close.
Far from retreating, though, Riyadh is pursuing race-to-the-bottom pricing even further. No matter that Opec member Venezuela, reliant on oil for more than 90pc of its export revenue and enduring a 9pc GDP contraction this year, is on the brink of civil war.
No matter that war-torn Libya, battling Islamic State of Iraq and the Levant and in the midst of its own civil conflict, is producing just 400,000 barrels a day, down from 1.5m under Gaddafi, absorbing the twin revenue shock of both far lower output and a much reduced price.
No matter that even Saudi itself is suffering – with cheap oil resulting in a 20pc of GDP budget deficit, and a large share of its fast-growing 30m-strong population highly reliant on oil-funded government handouts.
In February, the newly crowned King Salman dished out a reported $32bn (£21.1bn) to the Saudi people to “celebrate” his ascension to the throne, providing a stark illustration of the money-for-power bargain that sustains the House of Saud. If the money dries up, and Saudi royalty can’t pay, the world’s pivotal oil power could be plunged into political and civic chaos.
With the stakes so high, oil having fallen so far and US shale production dented, many expected Saudi to relent at last weekend’s Opec summit by announcing a new lower production cap. But it didn’t happen. Delegates left the meeting “visibly angry”, with some displaying “blank stares”.
One problem Riyadh has is that the US shale industry has shown grit and determination, with many small and medium-sized shale producers clinging on – and the Saudis don’t want to lose face. At the same time, if a new production cap is announced, the Saudis don’t trust other large Opec members such as Iraq (and particularly its arch-rival Iran when sanctions are lifted) not to break the cap, so muscling in on Saudi’s market share.
Then there’s Russia, outside Opec and constantly vying with the desert kingdom to be the world’s biggest oil producer. An Opec production cut, the increasingly paranoid Saudis fear, would make yet more room for Russian crude. And Moscow is less bothered about cheap oil than Riyadh – given that, in ruble terms, prices have not fallen so far.
The Saudis have revealed, then, their fear that Opec is now so stretched, its member states so rattled, that a new production cap would fail to stick, which would pave the way for “every man for himself” quota-cheating on a big scale, with non-Opec rivals also moving to grab more market share. Were that to happen, the power of the cartel, which still controls a third of all global oil production, would ebb away entirely.
Since meeting last weekend, Opec has revealed that total production rose by 230,100 barrels a day in November from the month before, to 31.695m barrels – a four-year high and largely caused by increased production in Iraq.
Having just failed to announce a new production cap, then, Opec just formally broke the existing 30m barrel ceiling – and by a wide margin. That’s why these new numbers caused oil to drop even more.
However, having said all that, I still believe crude prices could bounce back soon. One reason is that the “Chinese demand is falling” argument has been overdone. Yes, China is now growing by 5-6pc a year, rather than the 9-10pc annual average it has chalked up since the early Nineties. But the Chinese economy is now far bigger than it was just a few years ago, so its oil use still rises substantially, from year to year, even if growth slows. Photo: PA
The People’s Republic is on course to consume 11.2m barrels a day this year, according to the Energy Information Agency (EIA), a branch of the US government. That is 2.8pc up on 2014. Another 2.7pc increase in Chinese consumption is pencilled in for 2016. In the US, meanwhile, while oil inventories remain high, there are signs they’re now peaking.
The EIA has just announced that US crude stocks fell by 3.6pc during the first week of December, snapping a streak of 10 consecutive weeks of increases.
At the same time, the plucky US shale industry, having put on a brave face, is showing signs of genuine strain. Over the past year, the US “rig count” – the number of separate oil production centres in operation – has dropped by a staggering 62pc.
So far in December, we’ve seen a 7pc fall in a single week. It’s not surprising, then, that the EIA is now officially forecasting a hefty 6.1pc cut in US oil production next year, to 8.7m barrels.
Then there’s the broader truth that the “solution to low oil prices is low oil prices” – with cheap crude causing low investment in production and exploration, so sowing the seeds of a future price increase.
During 2015, the international rig count outside the US has so far fallen a massive 16pc. Across the entire world, investment in oil exploration and production has nosedived from $700bn in 2014 to $550bn this year. With oil now below $40, investment projects will now be dropping like flies.
Meanwhile, Western equity markets continue to soar. Distress levels in junk bond markets hit their highest levels last month since September 2009, according to Standards & Poors. And that alarming statistic derived largely from highly-leveraged North American energy producers doing everything they can to survive in this environment of artificially cheap crude.
So, low oil prices feel nice. But there will be relief in many quarters, not just among Opec members, when prices go back up.
FAR Price at posting:
7.2¢ Sentiment: Buy Disclosure: Held
Photo: Alamy
Photo: PA
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