November 05, 2014
The oil price movements in October were certainly significant . With conflict gripping the usual oil hot-spots (The Middle East, North Africa, Russia) it seems a fair enough question to ask why prices are dropping, when historically such events would force prices up. In answer to this apparent conundrum, we have two broad schools of thought around supply and demand. The demand argument – much loved by the media - contends that the world economy is grinding to a halt, Chinese oil usage is slowing and therefore the brakes are being put on oil consumption. Add to this economic slow-downs in Brazil, India and the spectre of Eurozone failure rising from its (very shallow) grave and you have both a dramatic and gloomy picture – hence the column inches and TV spotlight for the media loves nothing more than a good scare story.
But oil consumption is not actually falling. In fact oil demand continues to increase - just not at the same rate as a couple of years ago. Technically speaking a slow-down in demand growth (rather than demand decline) should mean that price rises are tempered, rather than the actual fall in price that we have witnessed. Therefore we should turn to supply to explain the situation and it is here that we have the key behind the price drops.
Quite simply, the world is currently awash with oil – far more than the current rate of demand growth requires – and this situation has been slowly building over the last 12 months. Oil production is buoyant wherever you look. Despite socio-political problems in Russia, Libya and Iraq, all of these major players are actually producing more oil now than they were in 2013. The dropping of sanctions against Iran at the end of last year has also ensured their oil has now joined the party and the biggest game changer of all is, of course, the glut of North American Shale Oil. All of these combined supply factors mean that in September 2014 the world pumped about 3m barrels per day more oil than in the previous September (2013). That’s about a 4% increase in world oil production in 12 months which tends to make the “Peak Oil” theory (fashionable a few years ago) seem rather ridiculous.
Talking of theories, there are a number of articles that speculate the “real” reason behind the fall in oil price is that the USA and Saudi Arabia are flooding the market with cheap oil in order to hurt Russia and support the sanction programme linked to the Ukrainian crisis. Many on the world wide web will no doubt believe this, but generating such self-inflicted pain is surely OTT for the Saudis.
As for the USA and despite what Conspiracy Theorists may believe, decisions on oil pricing are not made in the White House. Instead they are made indirectly by the hundreds of independent oil producers in Dakota, Pennsylvania and Texas who almost certainly have little interest in grand geo-political games. Instead they are focussed on pumping as much oil as they can into their local markets and they have been doing this very successfully for the last 12 months. So successfully in fact that they have pushed prices down, and having invested millions of dollars to get their shale wells up and running the drop in price to $80 per barrel will have come as a very unpleasant surprise.
Furthermore it’s more than possible that if prices fall even lower, returns may start to become insufficient, particularly for those operators who have borrowed to fund their original prospecting costs. Thus whilst it’s still probably too early to declare the end of the shale oil miracle, lower prices may well signal the end of the boom phase and a drop off in production would be the logical consequence.
Looking more locally, here in the UK, demand for heating oil has not been strained this year, with a very mild winter at the start of the year and one of the warmest Octobers on record last month, the market hasn't seen any surge in demand. Good news for offgrid energy customers who use heating oil as they have seen a big fall in prices for heating oil throughout 2014 and at present there aren't any signs that this is going to change anytime soon.