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Why Global Oil Prices Are Sinking

By: Guest Contributor - Jan 21, 2016, 11:45 am

EspañolBy Alejandro Demel

Crude oil prices in the global market have sunk to their lowest level in the last 12 years. According to the British Petroleum Statistical Review, there is currently a surplus supply of 15 percent compared to 2003.

Additionally, the slowdown of China’s economy, and the entry of Iran’s black gold into the global market, has generated speculation as to recent increase in the global supply of oil. Iran, it should be noted, holds the third largest oil reserves in the world, with 157 billion barrels, according to the latest OPEC data. Further, Europe and the United States have also recently ended their sanctions against Iran.

global-oil-prices

As the graph above demonstrates, the United States has increased its oil production by 86 percent since 2013, while Russia has increased its own production by 25 percent in that same time, thereby generating an increase in global supply. On the other hand, Saudi Arabia has maintained constant production levels, while Iran, whose production declined by 20 percent due to restrictions, expects to increase its domestic production by the same proportion in the coming years.

All this has an inverse effect on the price of oil: the law of supply and demand dictates that curves tend to adjust to the new reality of oversupply and decreased demand from slowing economies like China.

Morgan Stanley warned last week that further devaluation of the Chinese yuan could bring oil prices spiraling down to between US$20 and $25 per barrel.

Every major oil producer in the world is currently concerned with the price of this commodity, since it makes production unfeasible in certain areas where the cost of extraction is greater than the market price.

Faced with the reality that oil prices will likely remain low, countries like Russia are considering cutting back on government spending, since oil is its primary export. Russian Finance Minister Anton Siluanov has said that the country’s budget would only be balanced with crude at $82 per barrel, well above the $50 per barrel that the government used to calculate its budget for 2016.

Saudi Arabia is considering selling shares of its petrochemical and other “downstream” firms, and even shares of the state-owned giant Saudi Aramco, according to Saudi Arabia’s Deputy Crown Prince Muhammad bin Salman.

British Petroleum, one of the oil giants which formed part of the “Seven Sisters,” has announced that it will eliminate 4,000 of the 24,000 positions within its exploration and production units, according to company spokesman David Nicholas.

Brazil’s Petrobras has cut its investment plans for the 2015-2019 period by 25 percent, and warned that further deterioration in oil prices and Brazil’s local currency could lead to further revisions. In a statement, the state-owned film said that unmet operational goals led the administration to cut the projected US$98.4 billion investment.

According to a study by Rystad Energy, published in the Economist, the breakeven price of oil is different for each country due to differences in quality and quantity, in addition to the various forms of extraction being employed (offshore, onshore, oil sands, etc.). Extraction in countries like Nigeria, Canada, the United States, Egypt, the United Kingdom, Venezuela, and Russia costs between $60 and $70 per barrel.

Production remains feasible in Qatar and Norway at $40 per barrel, while the breakeven price in Iran and Iraq is between $30 and $20 per barrel. Ahead of the pack, Saudi Arabia and Kuwait can currently remain profitable in their oil production, since their extraction costs remain a mere $10 per barrel.

Alejandro Demel has a degree in economics from the Federal University of Rio de Janeiro (UFRJ). He specializes in UNR-ROFEX finance, and holds a masters degree in energy planning from UFRJ, and a PhD in economics from the Catholic University of Argentina. Demel currently works for Argentina’s Ministry of Energy.

Translated by Guillermo Jimenez.