A flame atop the Armada gas condensate platform, operated by BG Group Plc. Photo via Bloomberg.
On Wednesday oil prices dropped to just under $27 a barrel, their lowest since 2003. That's down 25% in the last year, and analysts are worried the price may keep falling. As the International Energy Agency told Reuters, the world could "drown in oversupply" of oil in 2016, along with other determining factors, like a shift to other energy sources weakening demand, and price wars between big oil and gas industry players.
These low oil prices have helped consumers at the pump, of course. They have also lowered the price of flights (down 15% since this time last year, according to NPR) while bolstering the bank accounts of some airlines. But there are losers, too. The oil and gas industry has seen 250,000 layoffs since the precipitous slide, according to oilprice.com, and the global stock market is down amidst fears stoked by the rout. (Though it did rebound slightly Friday, propelled in part by a small spike in oil prices.)
To find out what the hell is going on with the price of oil, what the instability means, and how bad things could get, we reached out to Delia Morris, a senior market analyst at Rigzone, an online publication frequented by oil and gas industry insiders that features in-depth coverage of news and data in the field. In an email exchange she explained that there is more at play here than just simple supply and demand—potential price wars between energy supplying nations, an Organization of Petroleum Exporting Countries (OPEC) not keen on cutting production that could stabilize the market, and conspiracy theories about market manipulation by key players abound.
VICE: What is the big reason oil prices have dropped so low?
Delia Morris: There are several factors why prices have dropped since June 2014. First the US tight oil boom (which started in earnest in 2009/2010) added millions of more barrels to the global crude supply, there was a panicked perception that we'd run out of storage to house it and tepid demand to consume it. (More of a supply shock). The first real acceleration in the price downturn occurred when OPEC had their fateful meeting on Thanksgiving, November 27, 2014, when the cartel decided to maintain production levels. The cartel has historically overproduced, or gone over individual country quotas, but this was a clear sign that the cartel was not after keeping a floor on global prices (which is theoretically their role in crude markets) and, instead, the name of the game was to go after market share. There were many theories around why OPEC (namely Saudi Arabia) would do this. I am of the opinion that it was to make better sense/better predict the behavior of the US shale players (force them to consolidate, not necessarily to put them out of business). Frontier plays (like the Arctic and ultra-deepwater plays) and Canadian oil sands (which require huge upfront capital costs) I think were targets (by OPEC) to forcibly put them out of business. And we are seeing that play out now.
In August 2015, oil started plumbing new lower levels due to news at that time coming out of China that pointed to an economic slowdown, or that the economic situation was worse than markets had originally thought. China is the world's second largest consumer of crude. The Yuan was devalued several times in the space of a week and there was tumult in their stock markets. Demand concerns abounded at this point and oil prices plummeted as a result.
Then we come to the next big marker, the OPEC meeting of December 2015, where Saudi and its Gulf allies basically said we're going to pump as much oil as we please and it's up to the non-OPEC countries (namely Russia and the US) to dial back their production in order to balance the market. For a time this past fall, Russia was producing somewhere around 10.8 million barrels a day, breaking post-Soviet records and was the world's largest oil producer. No one has dialed back production materially, in order to show a supply response. And this week, following the lifting of sanctions on Iran, the oil markets are even more worried that more supply will flood the markets in coming weeks against the backdrop of a slowing world economy, with China and other important emerging markets looking weak.
Who benefits when oil prices are this low? Who is hurt?
The main beneficiaries of lower oil prices are the refiners who use crude as an input. Their margins widen, which is the difference between their input price and their marketed petroleum product price (gasoline, diesel, heating oil, jet fuel, etc). Airlines also benefit as jet fuel becomes much cheaper. Of course drivers/consumers of gasoline have benefited as pump prices are at all-time lows.
Oil producers are the ones that suffer the most as oil prices drop. The profit per barrel falls and companies that get a realized price that is much lower than the benchmark are suffering even more. Producers who have high lifting (production costs) will suffer the most.
Will the price of oil keep going down? Why or why not?
Good question. Really, this price down-cycle has surprised everyone and is unlike other past price drops, so will have a longer and different trajectory than others (2008, 1986). Just as we thought there was a floor—for example in 2015 many thought when US onshore production finally rolled over—then we'd see a so-called "supply response" from the shale producers. Well, that never really happened and right now there are really no positive catalysts on the horizon for oil prices, either on the supply side or demand side. The US economy was a positive catalyst for a while in that there was an uplift in gasoline consumption because of lower prices, but that benefit is probably already played out. China was also consuming more oil in 2015, but that was not representing true demand and more to fill their strategic reserves. What we do know is that, theoretically, these prices are not sustainable.
We have to keep in mind that for conventional oil wells across the globe, the average decline rate is between 4.5% to 6%. All things being held equal, in order to replace supply for existing demand, we need to at least find new barrels to keep up with this decline rate. The implications of underinvestment by the oil industry because of the current conditions will have implications for supply in 10-15 years from now. The average time for deepwater/complex projects from discovery (when hydrocarbons are first found) to first oil is on average ten years.
The price will find a floor soon, but it might involve a catastrophic event, which usually happen during very fragile times. And these are fragile and jittery times!
We've already seen that the drop in oil prices affect the stock market. What do oil prices this low mean for the economy?
For the US economy low oil prices can spur deflation. Just as the Fed has given the go-ahead to raise rates, which will have a negative impact on the stock market, low oil prices (which are an indicator of low economic growth in emerging and developing countries in some ways) is having a negative effect on stock markets across the globe.
You mentioned OPEC opting not to cut production in order to stabilize the market. Might they do that down the line?
I believe there is more of a chance of OPEC breaking up than for them to stabilize the market. Venezuela, Algeria, Nigeria, and Angola are countries that are no longer benefiting by being part of the cartel and are pushing for price stabilization. Saudi is the de facto leader of OPEC and whatever they do/say holds sway. So we need to look at Saudi and what they are doing to determine if OPEC will stabilize prices. I think it will happen only when something catastrophic happens to their oil installations in-country. Then the price war will end.
If the price of oil continues to plummet or stays around where it is, what will the future of US oil firms look like?
In terms of the US majors (ExxonMobil, Chevron) and other big players that have global portfolios, they will benefit. They have the cash and wherewithal to sustain and grow through this. There will be buying opportunities for them and they have war chests to make acquisitions. As for the smaller shale players, many will go under, but the ones with good assets will possibly be picked up. Many of the shale players that are currently in the red are forced to keep producing in order to make their interest payments. So don't expect US production to fall. I think it will continue at this pace or even grow. Also, we know that offshore the US Gulf of Mexico production has picked up in the last year and will continue growing.
There are a number of conspiracy theories floating around about why oil prices are so low and who is pushing them ever downward. Is there truth to any of them? Is Saudi Arabia flooding the market with oil to hurt Russia and Iran, etc?
Sure, there are a lot of reasons why Saudi Arabia took the decision to basically eliminate their spare capacity and go all out and produce to the max and try and gain market share in Europe and Asia (they are playing a long-game). A lot of that was to gain market share from Russia and Iran, but also from the US. But as we have seen, Saudi Arabia may have pushed itself too far. The country for the first time had to sell bonds, institute austerity measures and cut back on other subsidies. They are playing a long game and are fighting proxy wars with Russia and Iran in Yemen and Syria, and oil is part of the mix. I think the biggest disruptor to all this is the US lifting of the crude export ban. I don't think the Saudi's had worked this into their calculus (at least the timing of it). So, if buyers of crude (ones that process light, sweet, which is what the US will mostly be exporting) start looking for a politically stable seller (i.e. the US), the US could obtain market share and back out Saudi crude, which is largely heavier and more sour and produces a lower yield for refiners than the US quality crude.
You can read Delia Morris' weekly discussion on oil prices and more on Wednesday's crash here.
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