Friday, November 28, 2014

Oil glut and falling prices

"Venezuela is Latin America's biggest exporter of crude oil and has the world's largest petroleum reserves." - Brian Ellsworth and Andrew Cawthorne, Venezuela death toll rises to 13 as protests flare Reuters 02/24/2014

This post is not mainly about Venezuela. But given the kind of unrest that country has seen this year, especially toward the first of 2014, I like to keep that reminder prominent.

Christopher Adams et al report on another twist in world oil prices in Market rout as oil slide rocks energy groups Financial Times 11/28/2014. The OPEC cartel has declined to lower production to boost oil prices, which produced a drop in price of energy company stocks:

The sharp slide in the price of Brent oil after Opec’s decision not to cut output triggered warnings that oil companies would cut as much as $100bn of capital spending in response, imperilling [sic] the US shale bonanza and threatening much Arctic oil exploration.

Meanwhile oil’s fall continued to play havoc with the currencies of oil exporting countries, especially Russia. At one point on Friday, the rouble slid to a record low. ...

Opec said on Thursday that it was leaving its output ceiling of 30m barrels a day unchanged, prompting a swift 8 per cent drop in the oil price, which was already down by nearly 40 per cent since mid-June. Brent fell $2.80 on Friday to $69.78, a four-year low.

The move showed that Saudi Arabia, Opec’s largest producer and effective leader, had decided to relinquish its traditional role of balancing the oil market by increasing or reducing output, letting prices do the job instead, analysts said. [my emphasis]
I'm not familiar enough with oil price politics and markets to jump to any big conclusions about what the recent drop in oil prices mean. With the possible exceptions of the JFK assassination and Area 51, few things give rise to as many bizarre conspiracy theories as oil price changes. So I'm trying to be parsimonious in any conclusions I might draw at this point.

The particular vulnerability of Russia, a major oil exporter, to problems from drops in oil prices is one major factor to watch. While it may reduce oil companies' megaprofits to some extent, it could have significant benefits for other sectors, as noted in the Adams article: "Falling oil prices, meanwhile, are driving down expectations for global inflation, putting additional pressure on central banks to step up economic stimulus programmes."

An earlier article by Geoff Dyer and Ed Crooks, Saudi Arabia tests US ties with oil price Financial Times 10/16/2014, focuses on Saudi Arabia's current role in the process, one of the more interesting aspects of this. The Saudis have usually been willing to help out the United States' geopolitical goals by their stands in OPEC. It's not entirely clear they are doing that this time: "At a time when the US and Saudi Arabia are fighting a new war together in Iraq and Syria, the Saudis have taken the bold step of asserting their pivotal role in the oil market and subtly squeezing the finances of some of America’s fledgling shale companies." It may be a stretch to say that the US and the Saudis are fighting on the same side, not least because the US currently seems to be fighting on multiple sides at once in the same conflicts.

On the other hand:

Yet, at the same time, the falling oil price will deliver a de facto tax cut for American consumers and – if sustained – will hit both Russia and Iran at a time when Washington is trying to pressure both countries.

Deborah Gordon, director of the energy and climate programme at the Carnegie Endowment, sees the Saudi pressure on oil prices as a carefully calibrated move that will not alienate allies but will cause problems for rivals and foes such as Russia and Iran.

“The Saudis seem to have concluded that this could be a game-changer for them,” she says. “They get several benefits without hurting the people they do not want to hurt.”

With global demand for oil slowing sharply and US production surging, Saudi Arabia faced a choice. It could have cut production to stabilise the market, shouldering the burden itself. Instead, it appears so far to have decided to let the price fall, indicating that it would be happy with an oil price around $80, rather than the $100 it has previously backed.
Another factor at work is that high domestic US oil production from shale (using fracking) is challenging Saudi Arabia's current heavy-hitter role in the world oil markets, so the Saudis may also be concerned to counteract that.

Venezuela, Washington's least favorite Latin American country right now - after the perennial least-favorite, Cuba, of course - has also been feeling negative effects from lower oil prices, as Sebastian Boyd reports in Venezuela Quelling Default Talk Spurs Bond Surge: Andes Credit Bloomberg Businessweek 10/30/2014: "Venezuela’s gross domestic product will shrink 3 percent this year, the most since 2003, according to the International Monetary Fund. The nation’s reserves have dropped 8.7 percent in the past year to $20.2 billion." Algeria, for some reason, apparently extracted extra from Venezuela from oil they imported in November the Venezuela needed for mixing with some of their oil. (Maher Chmaytelli and Sherry Su, Algeria Bucks OPEC Discounts as Crude Goes to Venezuela Bloomberg Businessweek 10/29/2014)

US ally Japan, however, is seeing some good and some bad effects. (Louise Lucas and Ben McLannahan, Oil price fall offers mixed blessings for Japan Financial Times 10/16/2014 )

Matthew Philips wrote last month (It Looks Like $80 Oil Is Here to Stay Bloomberg Businessweek 10/30/2014):

A “structural transition has been reached,” analysts at Goldman Sachs (GS) wrote this week, and the ability to determine oil prices has shifted from OPEC to the U.S. The report, entitled “The New Oil Order,” argues that it’s time for American oil producers to slow down in the face of weak demand growth around the world and the quick pace of change. Goldman predicts that U.S. West Texas Intermediate oil will hit $75 a barrel during the first half of 2015 and that Brent will settle around $85 a barrel, about where it is now.

The shale boom in the U.S. isn’t likely to pull back until oil gets so cheap that people can’t make money drilling for it. There are a lot of estimates of the break-even price for U.S. shale producers. Some think it’s around $80 a barrel, others think it’s closer to $60, and it’s obviously not going to be the same for everyone. The number changes depending on where you’re drilling and how good you are.
According to the Christopher Adams article linked above, there already seem to be at least threats from major producers to cut back on capital investment significantly at current prices.

Phillips also points to Russia and Iran as possible targets of oil-pricing decisions:

It’s hard to predict how Vladimir Putin or Iran’s leaders will react to the economic squeezes that are likely to come their way. A year ago, Iran signaled its willingness to negotiate over its nuclear weapons program after tight sanctions crushed its ability to sell its oil for a decent price. Those sanctions would not have been nearly as effective without the U.S. shale boom, which kept a lid on prices while the world turned away from Iran’s oil. Whether anything fruitful comes of it remains to be seen.

As for Putin, there’s no real evidence that lower oil prices are making him more compliant. If anything, they have made him more desperate. Still, lowering the price of oil is likely the most effective lever the U.S. has to pull at the moment—more effective than almost any economic sanction or diplomatic effort.

But Benjamin Bidder in Wegbrechende Einnahmen: Ölpreis-Verfall würgt Russlands Wirtschaft ab Spiegel Online 28.11.2014 discusses ways in which the low oil prices could be a major problem for Russia, even a regime-change size problem.

Carol Matlack earlier this week looked at how Russia is handling the oil price situation (Why Russia Said 'No Deal' to OPEC on Cutting Oil Production Bloomberg Businessweek 11/26/2014)

Juan Cole looks at the effects of low oil prices on Russia, Iran and Iraq in Oil Price Fall: Saudi Arabia targets US Shale Oil, Iran, Iraq, Russia Informed Comment 11/29/2014. But he doesn't see politics as the main driver in Saudi Arabia's unwillingness to have OPECC cut production:

The cause of the fall, by $40 a barrel, in petroleum prices since last summer is almost completely on the demand side. Asian economies, especially China, are dramatically slowing, and won’t be requiring as much petroleum to fuel trucks, trains and cars to deliver people and goods around the country. Most petroleum is used to fuel transport. Some is used for heating or cooling, as in Saudi Arabia and Hawaii, but that practice is relatively rare. US journalists seem to feel it obligatory to mention US shale oil production as a contributor to the price fall, since prices are a matter of supply and demand, and US supply has increased by a couple million barrels a day. But frankly that is a minor increase in world terms– global production is roughly 90 million barrels a day. Between Iran, Iraq (Kirkuk), Libya and Syria, enough oil has gone out of production to more than offset the additional American oil. It isn’t that there is more oil being pumped, it is that the world doesn’t want it as much because of cooling economies. ...

Saudi Arabia did not cause the oil price fall, though since 2011 it has been flooding the market to offset the decrease in Iranian exports because of US sanctions. Riyadh, however, is the main geopolitical winner here, which is why the Saudis stopped the Organization of Petroleum Exporting Countries from reducing country production quotas. (That step would have reduced supply and put up prices). As it is, the Saudis can afford to wait as fracked oil is driven out of the market because too expensive, so that they regain their market share. [my emphasis]
But Cole also adds, "The Saudis must enjoy punishing Iran and Russia for defying them by propping up the Bashar al-Assad regime in Damascus and the Da’wa Shiite regime in Baghdad."

Izabella Kaminska in A game of ‘chicken’ threatens the oil production balance Financial Times 10/30/2014 addresses the breakeven price point at which investment in shale production would become uneconomic:

Yes there is. According to Wood Mackenzie, US shale oil developments would remain economic even if prices were as low as $70 or $75 a barrel. Some even say that most American producers would break even if a barrel fetched only $57. But the difference is that in the US, none of the producers are state-owned. Also, America doesn’t depend on oil export revenues to balance the government’s books. True, lower prices might no longer be a cause of unalloyed economic cheer. Because they thin the wallets of oil producers, they make life harder for the people whose livelihoods depend on them. Still, cheaper oil could also help stimulate the economy by reducing the price motorists pay at the pump, and bringing down the cost of industrial inputs. That would help put more people in work, and give them more money to spend after they leave the petrol station forecourt. [my emphasis]
They are currently running just around $70/barrel (on Brent crude, the standard general measure cited). See: Yuji Okada and Sharon Cho, OPEC Inaction Signals Pain for Refiners With Costly Oil Bloomberg News/Yahoo! Fiance 11/28/2014.

Argentina could also be affected in its plans to boost energy production to the extent they involve fracking. (See: Benedict Mander and Jude Webber, YPF seeks foreign partners to tap Argentina’s shale Financial Times 11/02/2014)

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