International investors witnessed a further plunging in oil prices this week. The price of Brent oil dipped below $52.00 USD (United States Dollar) yesterday, indicating over a 4% additional decline. The cost for crude is now at a five and a half year low. Concerns about sluggish growth in Europe, East Asia and elsewhere are fueling investor concerns about a glut of oil in the international economy . Export leader Saudi Arabia, shows no sign of limiting supplies at this point. Financial markets around the world as a result, are roiling over the latest developments.
In the United States WTI (West Texas Intermediate) oil went below $50.00 USD for the first time since 2009. The plunge in the price of oil is permitting a 50% decline in the crude market from last year. Although original declines in energy prices were seen as a boon to the economy in the United States, the warning of a virtual collapse in the market is now reverberating with financiers and investors everywhere.
Production of oil is up in the United States and Canada with exports from the Middle East showing no signs of abatement. For countries dependent on higher oil prices such as Iran, Russia and Venezuela it spells a financial calamity. The present price structure of oil will hurt producers in the United States and around the world. Companies that derive their principle income from petroleum will find corporate revenues under increasing pressure.
These market realities are providing fodder for cautious investors leading to stock market declines around the world. It also continues to raise concerns that these lower fuel costs will contribute to a deflationary spiral namely in Europe and Japan.
The plunge in oil prices will cause energy companies to slow new investment which will effect further expansion in supply. It is estimated that total global investment in exploration and production of oil may decline by as much as 15%. As jobs are cut and less profitable sectors are reduced the glut in oil will begin to abate. Specific companies that overextended themselves in development of energy resources will find themselves deeply in debt. A number of less well managed companies will be absorbed by the soon to come consolidation in the energy industry.
Lower fossil fuels prices will also have a major impact in the alternative energy sector. Investments in solar, wind, thermal, and nuclear will all share a difficult market in 2015. These types of energy production are far less likely to make sense in a world of declining prices. Many of them will manage the situation only because of large government commitments and subsidies, that will not be changed in the short term.
In the past when prices were at this level, OPEC (Organization Of The Petroleum Exporting Countries) would cut production to stabilize prices. That may still happen if prices ratchet too low, but for the moment, the Middle Eastern oil producers are more concerned in maintaining market share. This explains why they as a whole, continue to charge less to customers in Europe.
Production has been rising in other areas of the world as the pressure to maintain energy income becomes more urgent. This is particularly the case in Russia where 50% of the national budget is dependent on oil revenues. The country needs Brent oil to sell for at least $96.00 USD to balance their books. That is unlikely in the present market. It also is contributing to the collapse in the value of the Russian ruble. The currency of Russia continues to decline as the plunge in oil prices advances. It has already lost over 50% in value in the past year.
Iraq in the midst of a civil war and in need of money, is rapidly increasing production. It is now exceeding rates not seen since before the American invasion.
The present over abundance of oil in the international market is at over 1 million barrels a day. This glut in supply is likely to expand even further, as refineries in the United Arab Emirates and Saudi Arabia ramp up production. This is the result of attempting to maintain their present market share.
Canada is also expected to increase the world supply of oil by hundreds of thousands of barrels a day, as more pipelines come on line in 2015.
An additional downward pressure on oil prices is the continuing strength of the United States Dollar. Most transactions in oil and other energy commodities are conducted with the American dollar. As the dollar increased in value in 2014, it helped to lower energy prices particularly in the United States.
The increasing value of the dollar corresponds with the weakening of the Euro, the Japanese yen, the Brazilian real and a number of other world currencies.
The question on the mind of many investors concerns production in the United States and Canada. Unlike oil extraction in the Middle East which is relatively cheap, in North America increased development is dependent on the technique of fracking. This process involving the injection of water to allow access to oil and gas is more expensive than traditional methods of extraction. The break even point in many of the shale fields in the United States and Canada averages $58 USD for a barrel. Economies of scale for larger firms and more productive shale areas allow for the cost of production to be reduced to perhaps as low as $50.00 USD a barrel. However, below that benchmark and the present level of output becomes uneconomical.
Many analysts in the industry are predicting even lower oil prices for at least the first half of 2015. There will be some stabilization in the second half of the year, due to the fact that more inefficient producers will need to cut back production in this new era of lower energy prices.
The low price is unlikely to continue indefinitely because as investment in the industry is cut back, future exploration and production will begin to decline. The surplus oil in the market will then be reduced. The present market condition will change.
The scenario that many investors and analysts may be discounting is a Black Swan Event. A reversal in the oil market can easily be achieved, if there was an interruption in supply. It would be easy to manipulate the market in this case, towards higher prices. Any disruption in the flow of oil from the Middle East for example, will bring a major change in the price structure for oil. The Strait of Hormuz in particular, is a waterway that is vital to the present world supply of crude.
A number of nations around the world have a major interest in attempting to bring about higher oil prices. This should not be discounted when making a determination about the future supply and price of commodities in energy. One thing is certain. There will be increasing uncertainty and volatility in oil markets around the world in 2015 and beyond.