Collapse of oil prices leads world economy into trouble

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The Organization of Petroleum Exporting Countries (Opec), the largest crude-oil cartel in the world, wanted others to feel its pain as oil prices collapsed.

“Opec wanted … to cut off production … and they wanted other non-Opec [countries], especially in the US and Canada, to feel the pinch they are feeling,” says Abhishek Deshpande, lead oil analyst at Natixis.

But in its rush to influence others, Opec ended up hurting everyone in the process – including itself.

Low oil prices, pushed down further by Opec’s meeting last week,have impacted world economies, energy stocks, and several currencies. From the fate of the Russian rouble to Venezuelan deficits to American mutual funds full of Exxon or Chevron stock, Opec’s decision was the shot heard round the world for troubled commodities.

So how low could oil go?

Standard Chartered analysts expect a “chaotic” quarter ahead, saying Opec’s decision to keep the production target unchanged is “extremely negative for oil prices for 2015”.

The bank slashed its 2015 average price forecast for Brent crude oil by $16 a barrel to $85.

Other forecasts are lower. Citi Research estimated an average 2015 price of $72 for WTI and $80 for ICE Brent. Natixis’s Deshpande said their average 2015 Brent forecast is around $74, with WTI around $69.

These prices have real-world effects on world economies. Everyone in the sector is smarting. Deshpande said because of how Saudi Arabia uses its oil well to support its entire economy, the country’s budget calls for $90 a barrel to break even, despite that the cost of production is closer to $30. Other Opec members have even higher budgetary breakevens.

Saudi Arabia is sitting on a “war chest” of money it stockpiled when prices were high, Deshpande said. Citi analysts said Saudi Arabia has about $800bn in cash reserves. Venezuela, on the other hand, is a prime example of a country squandering its riches. Citi said for every $10 drop in oil prices Venezuela loses about $7.5bn in revenues.

“Already weak fiscally, this should call for reducing energy subsidies. But domestic politics including the 2015 election makes this nearly impossible,” they said.

Opec countries as a whole could lose $200bn in revenue if Brent prices stay at $80, which is about $600 per capita annually, Citi said.

How did things get so bad?

Last week, when Opec nixed the idea of cutting its targeted production level of 30m barrels a day, the decision roiled the global crude oil markets. The news sent prices down 10% for the three main oil prices: US benchmark, West Texas Intermediate, and the Brent global benchmark. On Monday prices came off their Friday lows, but much of the damage remains intact.

In the short term, meaning at least for the rest of 2014 and for the first half of 2015, prices are likely to be weaker as production will overshoot the expected demand.

The picture may be clearer in the second half of the year as production growth in the US shale oil fields taper off and output elsewhere slows later in 2015.

It’s the longer-term outlook that may really change and can hurt the cartel.

In essence, Opec has declared open season. Opec’s decision may cause some of the US shale-oil producers to look for ways to save on costs, and other non-Opec producers may try to find ways to lower their production costs.

Here are the consequences: countries like Venezuela and Nigeria, which are already facing social unrest, may see even more domestic trouble. They didn’t have the fiscal or investment discipline to invest in their industry or save for a rainy day when they were flush with cash. The Middle East members of Opec may be able to sweat out several months of low crude oil prices.

For the rest of the world economy, low oil prices are a boon. They can help global gross domestic product growth. The International Monetary Fund (IMF) estimates that each $10 a barrel fall in oil prices increases world growth by 0.2%.

In the US, for instance, the lower oil prices may spur growth by boosting discretionary spending by Americans.

Don’t tell that to Europe and Japan. Weaker energy prices will be another demon to fight in their attempts to keep away deflation.

As oil supply outstrips demand, some industries will feel the pinch.

These low oil prices will hamper investment in infrastructure development, particularly outside the US. David Pursell, managing director at Tudor, Pickering, Holt & Co, an energy investment and merchant banking firm, says international exploration record is “abysmal”.

It’s likely that companies that supply shale oil – obtained by fracking – and crude oil will slow down operations.

Already some big producers like Apache announced production cuts even before the Opec meeting, and he said to expect more announcements from others in December and January.

In 2014 the US pumped about 11m barrels a day of both crude oil and natural gas combined.

Pursell said an average price of $70 WTI will mean no further expansion of US shale oil.

His firm still estimates US crude oil production will grow by 500,000 barrels daily next year, but that will come in the beginning of 2015 as firms halt expansion. 2016’s output to see now added growth, he said, as firms forgo drilling for new wells.

The low prices mean it will be harder for firms to raise cash either through debt financing or by issuing new shares of stock.

“A lot of companies are sitting down as we speak with board members figure out capex [capital expenditures] next year,” he said.

What happens next?

Don’t get used to cheap oil forever, Pursell said.

There might be a supply glut now, but when global growth increases, it will sponge up the excess.

“The only scenario where the US can’t grow and oil stays at these levels is if global demand is in tatters for the next two to three years. And we don’t believe that will happen,” he said.

Adam Longson, analyst at Morgan Stanley, agreed the lack of investment could push prices much higher in 2017 and 2018. Some international projects that were supposed to be developed are expensive and may be mothballed, meaning that when demand rises, supply might not be able to keep up. That could cause prices to rise sharply.

Consumers get whiplash from big swings in oil prices, he said. That ultimately hurts demand as it gives buyers reasons to “wean [themselves] off oil”, he added. Unlike in the past, there the potential for users to go to alternative energies is greater.

“The potential for substitution at higher oil prices is quite substantial, and permanent once in place,” he said.

Powered by Guardian.co.ukThis article was written by Debbie Carlson, for theguardian.com on Wednesday 3rd December 2014 12.15 Europe/Londonguardian.co.uk © Guardian News and Media Limited 2010

 

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