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Discussion Topics

27th November 2014

Falling Oil Prices

Since June this year, oil prices have declined by 20 percent.  The cost of crude collapsed by a quarter over the last three months after Saudi Arabia unexpectedly cut prices for exports to the US, adding to pressure on American energy producers. Although lower crude prices generally help consumers by reducing the amount they pay for fuel, analysts say falling energy prices will help squeeze profit margins.

If prices remain weak, which many forecasts and analysts suggest they will, governments from Moscow to Caracas, and from Lagos to Tehran will start to feel impact on macroeconomic policy.

The fall in crude price will have the most significant impact on the three major producers: Iran, Russia and Saudi Arabia.

Russia

The country is already suffering with weak growth, and the ongoing Ukrainian crisis and subsequent Western sanctions have exacerbated conditions.  Russia obtains more than half of its budget revenue from oil and gas, and its economy is therefore intrinsically linked to the crude price. The Bank of America predicts Russia’s economy will shrink by 1.5 percent in 2015. The falling oil price has already dragged down Russia’s currency and if oil continues to sink, the country will either have to draw down from its $74 billion foreign-exchange reserves or cut back on planned spending, a possibility suggested by President Vladimir Putin.

Iran

Iran’s economy recently started to recover after years of recession, and was on track to grow 1.5 percent this year and up to 2.3 percent in 2015.  However these predictions were made before oil prices dropped. If the oil price continues to fall, in the short term Iranian Government may need to make up revenues elsewhere.

Since last November Tehran has increased it sales of crude, especially to fund access to essential commodities. Amir Hadjani, of the Dubai-based RAK petroleum noted that in 2010, Iran was the fourth largest producer in OPEC, whereas today it stands in eighth place.

The US, EU and Iran are trying to negotiate a deal on the latter’s nuclear programme before a deadline in the late November 2014. If a deal is reached, and if the US and Europe offer a sanctions relief, it could help bolster Iran’s economy.  However, it could also push oil prices down further, as Iranian oil comes back to the global market.

Saudi Arabia

Although oil prices have dropped below Saudi Arabia’s break-even point, the country’s leaders remain confident that they can survive the reduced rates.

Saudi Arabia could respond by reducing its own oil production in order to support global prices. Officials in Saudi Arabia have signalled that lower prices could make some shale-oil producers in the US unprofitable and force the US to cut back on production.  This would be a favourable outcome for Saudi Arabia, as oil tends to be cheaper to produce than most shale oil projects in the US.

Saudi Prince al-Waleed bin Talal published an open letter on October 13th to the country’s oil minsters warning that “our country faces the danger of continuing to depend almost entirely on oil”

Some observers are worried about the longer term.  If oil prices remain at current levels per year, Saudi Arabia would only need to draw down around $10 to $20 billion of its $750 billion in foreign-exchange reserves.

At a panel discussion at an industry conference in Abu Dhabi on XX/XX/XX, OPEC secretary-general Abdullah al-Badri said “please do not panic, things will fix itself” (Reuters).

Some oil producers in the Gulf are keen to diversify and reduce dependency on oil.  For example, Adu Dhabi set up Mubadala to manage an investment portfolio that will achieve this diversification aim.

At the same time Abu Dhabi conference Kuwaiti oil minister Ali al-Omair told reporters that he didn’t expect OPEC to announce any cuts to its collective output when the organisation meets later this month on expectation that prices will stabilise soon.

On June 20th, the average annual price of West Texas Intermediate crude oil – a U.S benchmark - fell below $90 a barrel, down about $14 since June 2013, there are a number of factors that could contribute to an increase:

  • At this time of year, many refiners shut down for repairs and maintenance. When they come back on line, prices may recover.
  • Secondly, there can be a bit of irrational exuberance. The US has made huge strides in reducing oil imports, but it is still a major net oil importer.
  • Lastly, consumption increases when prices drop and economics recover. US total consumption rose 2.5 percent in 2013, the largest increase since 2004.

The administrator of the Federal Energy Information Administration, Adam Sieminski, has cautioned that petroleum consumption could climb 38 percent between 2010 and 2040, almost entirely due to growth outside the Organisation of Economic Cooperation and Development countries. This could mean much higher prices.

For some companies this will present challenging operating conditions for the next six months, while waiting for the recovery. For others, we have seen a switch of focus from large, expensive offshore operations to a more onshore focused model. Plays such as onshore East Africa have been in the forefront of companies’ minds for a while, and these now seem like an increasingly attractive option considering relatively low set-up costs.

Also as mentioned in “Production systems – taking a look back to move a company forward” (http://www.gravitasrecruitmentgroup.com/oil-and-gas/discussions/2014/11/production-systems-taking-a-look-back-to-move-a-company-forward/) – the focus could switch quite considerably to developing brownfield sites.

If you have any thoughts how oil prices may continue to fluctuate, or the factors affecting this, please do get in touch.  We would be interested to hear how it has affected your company and how they are dealing with the price drop.

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