Monday, December 22, 2014

Falling Crude Prices

Crude prices have been plummeting down since the middle of this year

1 Year Crude Oil Prices - Crude Oil Price Chart
Crude prices are now dipping the $60/barrel mark, much below the $100-120 range in which it had been moving for the past few years. Chief reason for the collapse is being supply outpacing demand (basic economics). Quite a few reasons have been attributed to this.
  1. The Shale supply has enabled US to become self-sufficient (for now) and hence it doesn't need to import further.
  2. Economic slowdown in Europe which is still not fully recovered from the recession.
  3. The OPEC cartel is not united. And Saudi Arabia, the only ones with the spare capacity, are unwilling to cut production.
While lower fuel prices seem to be a good thing at first sight, this sharp dip in prices will have a major impact all round the industry.
  1. Revenue calculations gone haywire, not just for the big oil companies but also for governments who have a substantial part of their budget sourced from taxes on oil & petroleum products.
  2. Quite a few upcoming projects have been put on hold because the economics don't work out anymore. The projects become viable only if the costs go down. The supply chain generally lags behind the crude prices by a couple of Quarters, hence the projects might see quite a lengthy delay.
  3. Marginal plays (e.g. Deepwaters, Unconventionals etc.) which had opened up due to higher crude prices may have to be put on hold. 
  4. The alternate energy sectors (solar, wind, bio-fuel etc.) have to compete with these lower prices. This certainly delays their arrival as a big energy source.
  5. Consolidation in the oil industry - Many players may be put out of business. Even the big companies are feeling the pinch. The second largest oilfield service provider Haliburton has bought Baker which was the third largest service provider. The M&A market may become quite busy in the days to come.
Normally when the prices have fallen the Saudis have intervened. They have cut production reducing supply. But this time they have chosen not to act.

Quite a few conspiracy theories are going around on their possible motives. The most obvious one is to destroy the competition. Saudi crude is available at much lower production costs than Shale or deepwaters. So when prices fall dramatically the Saudis will be the last to feel the pinch. 

Below are some of the theories doing the rounds. Most of them have less to do with economics but more to do with geopolitics.
  1. Destroying US Shale - US Shale boom is considered the chief reason of this price drop. Ironically this boom happened only because the prices had breached the $100/barrel mark in the first place. Now that the Shale industry is well developed, we have to wait and watch how long they can hold up.
  2. The OPEC cartel has seemingly run its course. The Saudis are the only ones with any swing production capacity left. So there is a theory that they will let the prices drop till the other OPEC members take a hit on production. Probably leading to the demise of OPEC.
  3. Collusion between US and Saudi Arabia to stop the further development of the Russian oil industry. Russia may have even bigger reserves than Saudi Arabia but its more difficult to access, thus needing higher costs to sustain. Russian rouble is already in trouble and interest rates have been boosted up from 10.5 to 17% in Russia. 
  4. A pre-dominantly Sunni majority Saudi Arabia does not want a Shia majority Iran to get oil revenues. Plain and simple.
Many theories doing the rounds. But oil prices have a major impact on world's economics. Falling oil prices will reduce inflation, creating more spare cash, which will be hopefully pumped back into the economy causing the economy to boom again, creating more demand for oil and pushing prices up. But this cycle will require at least a year's time. And during this period the industry may have already undergone a drastic upheaval.

Interesting times are ahead not just for the worried oil industry but also for the world economy as a whole. We will have to wait and watch what impact this churn has on the energy industry.

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