Oil Investors Drowning in Sea of Crude
Crude oil prices are testing new lows this week, as the bad news keeps piling up for the global energy sector. With the Organization of the Petroleum Exporting Countries (OPEC) deciding not to reduce oil production during its December 4 meeting in Vienna, the proverbial line in the sand has been drawn. With no oil-producing country willing to reduce its drilling efforts, it looks as if the oil price forecast cut will hit multiyear lows and stay lower for much longer than anyone expects.
It seems that despite massive budget deficits due to the ongoing oil price collapse, Saudi Arabia is more determined than ever to battle rival producers to the bitter end for the market share it lost in recent years. While OPEC had generally been responsible for approximately 40% of global crude oil production, this figure was slowly eroded by competitors, such as the U.S. shale oil industry since the 2008/2009 financial crisis. (Source: “Supply: OPEC,” Energy Information Administration, last accessed December 7, 2015.)
OPEC could have taken the path of slashing its upper production limit, which, for about four years, was in the range of 30 million barrels of crude, which would have had the near-immediate effect of providing uplift to oil prices. Of course, this policy would have to be led by Saudi Arabia, the implicit leader of the oil cartel.
As the swing producer, the kingdom could very well have set production rates at a level more comfortable for its fellow members. Such a policy would almost certainly have been welcomed by the group’s smaller producers such as Venezuela, Ecuador, and Algeria, whose energy-dependent economies are experiencing profound financial issues as a result of the low-oil-price environment. (Source: “Saudi Arabia, Allies Willing to Cut Oil Production If Others Follow,” The Wall Street Journal, December 2, 2015.)
Why, then, has the organization decided to explicitly go against this logic?
OPEC: Determined Not to Lose Market Share
The Saudi argument for maintaining near-record oil production levels is that increased competition from non-OPEC countries threatens to undermine their market share. Indeed, memories of the oil price crash in the 1980s are still fresh, where Saudi Arabia used its position as the global swing producer to lower production and raise crude prices. The result, however, was a loss of market share, which took the kingdom years to claw back.
It seems the Saudis are determined to never again repeat this scenario.
With much of the surge in oil production coming from U.S. shale, it’s believed that a prolonged period of sub-$50.00 prices will render this competition uneconomic and force cutbacks. The strategy appears to be working, with declining rig counts in U.S. shale plays, albeit nowhere near the levels expected. American competition has proven increasingly resilient to the oil price crash, with companies raising production efficiency in an effort to stay afloat.
Chart courtesy of www.StockCharts.com
The flipside is that the strategy has hurt OPEC members more than it has hurt non-OPEC countries. As mentioned, poorer members of the cartel are experiencing financial pressure, but even Saudi Arabia is now feeling the squeeze. (Source: “Saudi Arabia’s big welfare spending faces the oil abyss,” CNBC, December 3, 2015.)
Despite the oil-rich Gulf countries having massive reserve funds, even these will not last forever if the low-oil-price environment continues. Standard & Poor’s dropped its rating of Saudi Arabian sovereign debt on October 30, citing an alarming budget deficit in the kingdom.
The biggest reason for the decision not to cut oil production is likely that two of the biggest producers simply will not play ball. They both have their own interests to attend to; as a result, Iran and Russia are not onboard with the idea of production cutbacks. (Source: “Iran, Russia reject idea of joint oil output cuts with Saudi Arabia,” Reuters, December 3, 2015.)
Despite not performing as badly as many expected as a result of Western sanctions, Russia’s economy needs every dollar it can squeeze out of its petroleum exports. In fact, Russia almost beat its post-Soviet oil production figure in November, at almost 10.8 million barrels. (Source: “Russian Oil Output Close to Record Level as OPEC Set to Meet,” Bloomberg, December 2, 2015.) Iran, eager to return to oil markets after years of sanctions, is not willing to sacrifice a moment to lift prices. Tehran expects to see a surge in domestic oil and gas production once U.S. sanctions on its energy sector are lifted in 2016.
The possibility of a throttling back of oil production may have been torpedoed from the get-go, then, as the underlying problem still persists. No single country has much of a reason to comply with such a policy and with national budgets, sanctions, and various geopolitical interests hopelessly interchanged in this volatile mix, every major oil-producing state is hoping to simply outlast the competition.
Oil Price Forecast 2016: The Bottom Line
It really doesn’t matter what various market analysts and economists were predicting would result from the latest OPEC meeting.
The result was the same as it has been for over a year now and no respite for oil prices from the global cartel seems likely in the near future. The question on everyone’s mind is just how far this process will take itself. With global supply still outweighing demand by several million barrels per day and global crude oil stockpiles rising for months now, the economic fundamentals are certainly working against the oil price forecast.
Add to this mix global economic volatility, slowing growth, energy demands in emerging markets, and various geopolitical hotspots, it’s no surprise that I remain highly bearish on the oil price forecast. Expect oil prices to not only stay under $50.00 per barrel for the immediate future, but perhaps even test new lows and hit $30.00 per barrel before 2016 is upon us.