 "The OPEC logo is seen at OPEC's headquarters during a meeting of OPEC oil ministers in Vienna, Austria")
Fall in share prices have impacted investors, fall in oil prices have severely impacted economies. Fall in oil prices, on account of increased supplies and falling demand led by a slowdown in China have not only impacted oil producing countries but has had a domino effect on a number of countries.
But this time, the duration of the fall is the biggest worry. The current slump in oil prices that has lasted 18 months is now the worst in post-gulf war history. The big question now is not how low can oil prices go but how long will the slump last. If OPEC (Organisation of the Petroleum Exporting Countries) is to be believed, then 2016 will be the year when the balance of oil trade shifts back to OPEC.
By refusing to cut production and lose market share to shale oil producers like the USA, OPEC nations have flooded the market with oil. This has led to International Energy Agency to declare that the world ‘could drown in oversupply’ and enormous strain would remain in the oil market. Removal of international sanctions on Iran is about to see a new flood of crude oil into an already oversupplied market.
Iran’s national oil company has already ordered an increase in output of 500,000 barrels per day (bpd). 50 million barrels held in reserves were already on tankers ready to be shipped to buyers in Europe. Higher supply from the fourth-largest country with proven oil reserves is one of the many reasons cited by the International Energy Agency in its bearish forecast for prices this year.
While on the one end we have a major player entering the market, another recent player in the oil market is slowing down production. Reports say the sharp fall in oil prices has resulted in a fall in oil production in the U.S. Not only has production fallen in the country but the damage is widespread.
According to US Energy Information Administration (EIA), the country's oil production is set to decline to around 8.7 million bpd this year, compared to 9.4 million bpd in 2015. In fact, US has already started importing oil from other producers. Canadian crude oil exports to the United States reached its highest level ever of 3.4 million barrels per day in the first week of January, according to preliminary data from the EIA.
Further, U.S. imports of light crude from across the Atlantic are set to jump this month to their highest in more than two years. Shipments totalling some 500,000 barrels per day (bpd) are booked or underway from producers including Norway and Nigeria, a surprisingly rapid revival of flows that had dwindled to nearly nothing in 2014-2015, after the U.S. shale oil revolution got in full swing.
Imports have also picked up on account of the arbitrage opportunity as a result of an inversion in the spread between benchmark U.S. crude oil prices and global Brent. After five years at a discount due to the eruption of domestic production, U.S. futures are again trading at a premium of $1 a barrel or more in the months ahead.
This does not take away the fact that U.S. oil production is declining more quickly than analyst estimates. A study by Wood Mackenzie calculated that 68 "megaprojects", representing an investment of $380 billion, has been deferred or abandoned. The number of oil-rigs operating onshore in the US has fallen by about two thirds from its peak in 2014, but production remained relatively stable because they were becoming more efficient.
However, production from wells in shale formations drops sharply by up to two-thirds in their second year. With new investment in the US shale oil industry having fallen sharply, there are unlikely to be enough new wells being drilled to compensate for the loss of existing reservoirs.
Collateral damage of low oil prices on the US Shale gas economy has been severe. More than 100,000 jobs are gone, most of them last year. The number of shale rigs in service have collapsed by 60 per cent. Banks are worried about their oil loans. Shale states are readjusting budgets for shortfalls. About $200 billion of oil and gas assets are up for sale world-wide. Reliance Industries in its December quarter numbers too pointed out that it is not commissioning new rigs and shutting down some of them.
American shale oil companies, who were one of the reasons for the strength of the US economy have been hit hard. Last year two dozen companies defaulted and 15 filed for bankruptcy. Standard & Poor’s have assigned junk ratings on three-fourths of the oil and gas producers it monitors. More than 50 oil and gas producers are generating negative EBITDA (Read here). Many are living on borrowed time and are dependent on the generosity of their bankers and bondholders.
OPEC clearly has the upper hand in the control for oil market share, and has claimed victory in the battle for market share (Read here). But with supplies higher than demand it is unlikely oil prices will move higher anytime soon. OPEC nations who are profitable even at the current level of oil prices would like to see the shale producers bleed themselves to bankruptcy before they agree on a cut.
Battle for market share will ensure that prices do not increase, especially with Iran joining in. Slump in oil prices may continue for some more time and might see more bloodshed in the shale oil camp.
