The Oil Price Tumble

The global slowdown combined with the downturn in the oil industry carries inherent risks of possibly more difficult market conditions in the future. Such a prospect renders the management of the principally local private sector and overseas funded projects mobilising more than Rs 100 billion of investments to steward the country to a high income economy, much more challenging

The history of the world oil industry has been marked by booms and busts. Reserves built from windfall gains during periods of high oil prices have normally helped oil producing countries and multinational oil companies tide over the low end of oil price cycles. This no longer seems to be the case as the structure of the world oil industry has changed materially since 2008 when oil prices fuelled by Chinese surging growth rose to over $140 a barrel. This is evidenced by the dire impact of the current slump in prices on major oil producers and multinational oil companies. The forecasts are that the oil industry is going through one of its worst downturns since the 1990s and that oil prices are not likely to recover from the present bearish conditions in the foreseeable future.

The quantum fall in oil prices from about $110 a barrel from 2010 till mid 2014 to below $27 last month has dwindled oil generated foreign currency reserves and seriously impaired the public finances of oil revenue dependent countries in the world. Even Saudi Arabia, the largest OPEC oil producer and the current largest oil exporter in the world was forced to introduce austerity measures in December 2015 after registering a second and record budget deficit in a row.

Income from oil accounts for more than 90% of public revenues in Saudi Arabia. Faced with a ballooning budget deficit of US$ 97.9 billion or 15% of its GDP in 2015, Saudi Arabia adopted spending cuts, subsidy reforms including raising the price of gasoline (which was among the cheapest in the world at the pump) by 40% and proposals for privatisations to reduce the huge deficit. Prices of electricity, water, diesel and kerosene have also been increased. The Saudi government forecast yet another budget deficit in 2016 amounting to US$ 87 billion.

A reduction of subsidies on oil prices has the beneficial effect of reducing oil and energy consumption thereby diminishing greenhouse gas emissions. Lower oil prices also mean that the use of coal which pollutes more as it releases much more carbon dioxide in the atmosphere than other fossil fuels such as natural gas or oil should be promptly phased out. In line with our COP21 commitments, this scientific reality must be factored in, in our national energy policy framework.

Falling oil prices and Western sanctions have also taken their toll on Russia, the second largest oil exporter, where oil and gas account for 70% of export revenue. As a consequence, the rouble has plummeted against the US $. GDP which contracted by 4% in 2015 is forecast to again contract by 1% this year. There are questions being asked in Russia about the sustainability of a model of development so dependent on oil and gas.

Nigeria, which is Africa’s largest economy and biggest oil producer, is in spite of a diversified economy, still heavily dependent on oil which accounts for more than 70% of all government revenue and some 90% of the country’s exports. Sharply falling oil prices have stunted economic growth. According to the IMF, after a decade of robust growth averaging 6.8% a year, growth is slated to have slumped to about 3.25% in 2015. This has undermined public finances and a sagging economy and put immense pressure to devalue the Nigerian Naira which shed 25% of its value last year.

From Brazil to Mexico or Venezuela, tumbling oil prices are taking a heavy toll on oil producing countries across the world. Lower oil prices have also led oil companies to decommission about two-thirds of their oil-rigs and significantly curtail their investments in exploration and production. Some 250,000 oil workers are estimated to have lost their jobs.

Financial results published this week show that multinational oil companies such as BP have reported record losses in 2015 and will axe 7,000 jobs whereas Exxon Mobil, the US largest oil industry player reported a 58% decline in its quarterly profits. Royal Dutch Shell warned that it expects a similar fall in profits. These poor results from oil giants coupled with low oil prices of crude have weighed on stock markets on both sides of the Atlantic and caused stock market indices and values of these oil companies to fall.

New market dynamics

The international oil market has undergone a profound structural change over recent years. Analysts point out that the materially changed market dynamics limit the prospects of an oil price recovery anytime soon or the likelihood of a low oil price driven impetus to world growth.

The development of the production of shale oil over the last five years in the US, although representing only 5% of global production, has demonstrated that alternative sources of oil presumed to be difficult to exploit can be tapped. This has had a bearish impact on market sentiment. The US has thus been able to extract millions of barrels of additional oil per day from shale rock deep underground through substantial improvements and innovation in shale ‘fracking’ technology. From being significantly dependent on foreign supplies of oil, US was thus able to nearly doubled its oil production from 2008 levels to become the world’s largest producer of oil and gas, surpassing Saudi Arabia and Russia.

The increasing US domestic production of oil from shale has thus displaced imports from traditional suppliers such as Saudi Arabia, Nigeria or Algeria. These countries now have to compete for outlets in the Asian markets causing oil exporters to discount prices. Furthermore, the slowdown in China, the emerging countries and the world economy as well as the increasing use of more energy efficient technologies in manufactures and vehicles or greener energy sources have weakened global demand for oil.

Despite the glut in the oil market, OPEC countries led by Saudi Arabia, the largest OPEC oil producer, have since November 2014 taken the strategic decision to maintain oil production instead of cutting it to boost prices. The OPEC reasoning was that the falling oil prices in an over supplied market would drive out higher cost producers such as producers of shale oil or those extracting oil in more difficult conditions in the hinterland of the Arctic or Russia, in Canadian oil sands, in Brazil and Mexico from offshore pre-salt layers, etc., from the market and enable more efficient producers to regain their market share of oil exports. This strategy has not paid off as the oil industry has proved to be more resilient than expected. Some analysts have shown that even at $30 a barrel, most producers continue to maintain throughput as they are able to cover their operating costs.

According to an IMF study, the oil price needed by various OPEC member countries to balance their budgets taking into account their population sizes in relation to their oil revenue vary enormously. These range between $77- $81 per barrel for Qatar, Kuwait and UAE to $101-$131 per barrel for Iraq, Saudi Arabia, Russia, Venezuela, Nigeria, Algeria and Iran. The current low oil price level is a measure of the serious financial predicament of the most important oil producers in the world. In a market context of chronic oversupply of oil and high inventories, exacerbated by the entry of Iran as a major exporter in the market as well as weak demand for oil owing to the global slowdown, future prospects for oil prices remain bearish.

Managing risks

It is obvious that low oil prices have a positive impact on oil importing countries in the context of the global slowdown. In the local context, it obviously begs the question of whether the prices locked in by the State Trading Corporation on its forward oil purchase contracts reflect and take full advantage of the low oil price trend for the benefit of both economic operators and consumers. This is too vital an issue for the economy. The authorities must therefore ensure that this is so and that transparency of the process prevails at all times.

The world presently faces a unique situation with a very large cross section of the world’s major economies facing difficulties. Major drivers of world growth such as China, most of the emerging countries and the global economy are all experiencing a slowdown. The US and Europe are growing very slowly. Similarly, the major oil producing countries such as Saudi Arabia, Russia, Nigeria, Venezuela, Brazil or Mexico are facing dire consequences owing to tumbling oil prices. The combination of these adverse factors hobbles the prospect of low oil prices acting as a robust engine of global growth.

The growing apprehension is that the global slowdown combined with the downturn in the oil industry carries inherent risks of possibly more difficult market conditions in the future. Such a prospect renders the management of the principally local private sector and overseas funded projects mobilising more than Rs 100 billion of investments to steward the country to a high income economy, much more challenging. The government must therefore get its act together accordingly.

Mrinal Roy

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