Turmoil in the Oil Industry

In the first half of twentieth century, oil had importance because of its need for military. Anyone who had control over oil had ruling power. During World War I and World War II it played an important role. Also, it was important for industrial growth in U.S. and other powerful nations. It was used for energy consumption. As this all has wide impact on every nation, oil price has importance in the international market.

Difference between Brent crude oil and WTI crude oil

Brent crude oil and West Texas intermediate are 2 major benchmarks in world market. The oil explored in Central U.S., Northern Region of Europe and Asia –Pacific region is ‘Sweet’ oil i.e. content of sulfur is less that 50%. If the content of sulfur is less, then it is easier for refiners to refine it. Though Brent and WTI both are sweet and lighter oil types, WTI is a bit sweeter than Brent oil and it makes WTI costlier than Brent. But, if a supply glut is there at Oklahoma, Texas then prices of WTI tumbles down. Still, currently around two thirds of world oil trade happens with Brent crude as benchmark.

1930’s oil glut:

Discovery of new oil field in Oklahoma, Texas caused abundance of oil in 1930’s. In late 20’s and early 30’s world was in fear of low oil supply which in turn led to discovery of new oil fields. This caused overproduction of oil which was stockpiled and this led to excess supply of oil and gasoline at refineries. This led to price fall. Also, this further exacerbated the deflation.

To curb the tumbling oil prices, authorities tried to shut oil wells in oil producing states. But, it was not much successful.

1980’s oil glut:

There were 3 factors responsible for 1980’s oil glut: increase in oil prices in 1979, excess production and decline in demand due to recession. Excess production took place due to the rise in prices of oil. All 3 factors are intertwined with each other. In 1982, supply was more than the demand of oil. This led to the price war and in turn around 67% fall in oil prices. To curb the fall in oil prices, Saudi reduced the production of oil. But due to this, Saudi and other OPEC countries lost the market share. This resulted in the gain of market share by U.S. and non-OPEC countries. Also, after learning from 1973 oil crisis and 1979 oil shock, European countries focused more on stable, alternative oil supplies from non-OPEC countries. This crisis ended with loss of market share by OPEC nations and reduced their importance.


Current turmoil in the oil Industry

Price of a barrel of oil has fallen more than 70% since June 2014.The oil industry, with its history of booms and busts, is in its darkest phase since the 1990s.

Oil production in the US has nearly doubled over the last few years because of the Shale boom. This lead to a substantial decline in oil imports in the US. Saudi, Nigerian and Algerian oil that once was sold in the United States was suddenly competing for Asian markets, and the producers were forced to drop prices. Canadian and Iraqi oil production and exports are rising year after year. Even the Russians, with all their economic problems, manage to keep pumping.

The consequent increase of oil in the market due to the rise in oil production in the US has lead to the supply outpacing the demand by quite some margin. The OPEC and Non OPEC members are trying to hold on to their positions and not cutting productions in a bid to run their competitors out of business. But this has put a lot of economic strain on all the oil producing countries as prices have dropped substantially and they cannot carry on like this for a very long time. Many of the US shale producers until now could carry on producing oil because of contracts signed at higher prices. But these contracts are getting over this year and many producers will have to shut down operations simply because they will become unprofitable.

Meanwhile, projects capable of producing more than a half million barrels a day of oil were cancelled, delayed or shelved by OPEC countries alone last year, and this year promises more of the same.

Also there are signs that production is falling because of the drop in exploration investments. A international consulting firm, identified 68 large oil and natural gas projects worldwide, with a combined value of $380 billion, that have been put on hold around the world since prices started coming down, halting the production of 2.9 million barrels a day.

But still the drop in production is not happening swiftly enough, especially with output from deep waters off the Gulf of Mexico and Canada continuing to build as new projects come online.

On the demand side, the economy of Europe is weak. China unexpectedly is going through a slowdown of its own and its oil consumption isn’t increasing the way it was expected to increase. Other emerging economies are also stable and there is not any extra demand for oil.

A Major factor in the sharp price drops is due to the continuing unwillingness of OPEC to intervene to stabilize markets that are widely oversupplied.Venezuela, Ecuador and Algeria have been pressing the cartel to cut production to shore up prices, but Saudi Arabia, the United Arab Emirates and other gulf allies are refusing to do so. At the same time, Iraq is actually pumping more, and Iran is expected to become a major exporter again.
Saudis fear that if they cut production and prices go up, they will lose market share to their competitors (mainly US). The IMF estimates $300 billion decline in the revenues of Saudi Arabia and its Persian Gulf allies this year.

Oil prices are unlikely to increase anytime soon as this game of brinkmanship continues. Oil production is not declining fast enough in the US and other countries but that could begin to change this year. There are signs that suggest relative parity between demand and supply along with the prices could be achieved by the end of 2016. Demand for fuel is recovering in some countries, and that could help crude prices recover in the next year or two. But there is now little or no spare production capacity to give the market a cushion in case of any crisis in a crucial oil-producing country.

Oil Price Forecast for 2020 and 2040

The average price of a barrel of Brent crude oil will rise to $79/bbl by 2020(without considering Inflation). Shale oil production is going to slow down after 2021 there by contributing to a decline in total U.S. oil production through 2040.

According to Annual Energy Outlook (EIA), after 2020, world demand will start driving oil prices to the equivalent of $141.28/barrel in 2040. By then, the cheap sources of oil will have been exhausted, making it more expensive to extract oil.

This all depends on what happens with U.S. shale oil production, how OPEC responds to it, and how fast the global economy grows. Also EIA is uncertain about its own forecast. What will happen to the oil prices in the long term is anybody’s guess.










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