As a Christmas treat to folks in the ForexLive universe, our very own Lilac has put together an awesome post on the current ins and outs of the oil market. Next year we hope to increase reader interaction and Guest Trader will be coming back into a regular slot and Lilac’s post is a little taste of what to expect.
Who knew what the year would bring as 2014 unfolded with oil prices trading above $100?
The effects of six months of plummeting prices are not only damaging to Russia, but also Iran – two economies sitting on opposite sides of the argument for cutting production in the face of a 2 million bpd crude glut that has built up in the market – and two of the most poorly managed economies in the world. That is, aside from oil.
One hoped for upside to this however, is that conflicts emanating from Russia may be resolved all the sooner. And certainly the problems Iran faces after years of crippling sanctions should render it more malleable while the stakes still remain high in Tehran’s nuclear programme discussions.
With Russia dominating the headlines so much it’s probably worth repeating that, before the November OPEC talks it had been mooted that Russia – the world’s 2nd largest oil exporter – would agree to curbing its oil production by around 300,000 bpd from next year in return for OPEC limiting its output by another 1.4 million bpd. Bearing in mind that Moscow’s relations with OPEC have long ago been soured, not only due to Putin’s close ties to the Syrian regime, but by his country’s pledge to cut output in tandem with the group in the early 2000s – when Russia failed to follow through, and instead increased exports – it was an unlikely scenario then, given that Russian oil output has risen to a near post-Soviet record of 10.61 million bpd since September. In the event of course, talks to cut output failed, because Russia refused to cut.
One explanation is that Moscow can’t easily turn off the tap in Siberian oilfields, where it’s difficult to shut down wells during winter, unlike Saudi Arabia, which has the ability to react quickly. What’s more, the Kremlin has been somewhat cushioned from the price decline by the sharp fall in the value of the ruble. Even though the dollar value of its oil exports has fallen, their value in rubles has remained relatively steady, so the government can still collect enough oil taxes to cover pensions and other budget obligations.
And Rosneft’s Sechin reckons that Russian oil companies are accustomed to dealing with sharp price fluctuations – even below $60, it isn’t so dramatic for them that it would require immediate production cuts.
The main reason for Russia’s reluctance, though, is that it really can’t afford to sell less oil.
Oil exports are the country’s key source of hard currency, particularly as Western sanctions have significantly limited Russia’s access to global capital markets. And Russian oil companies need to keep that money coming in, as it becomes more expensive to extract oil from dwindling reserves in their main Western Siberian oilfields, where in fact enhanced techniques are necessary even to keep production flat, let alone increase it.
Thus while Russian oil production might dip slightly if lower prices make some marginal wells uneconomical, Russia will not be deterred from keeping the spigots wide open. Neither, I suspect, will the US, given that it’s in the fast lane to overtake Russia … which is why Ryan nailed it when he wrote [of Saudi oil minister Ali bin Ibrahim Al-Naimi ] “he’s made a good point though, why should OPEC cut just because non-OPEC production has risen? That’s what makes a market.”
The ten large oil producing and exporting countries combined account for 6.5% of global GDP.
And of the ten largest oil importing countries, the EU, US, China and Japan account for 65% of global GDP.
So in bare terms, the numbers speak for themselves.
At current prices, between $300-400 billion annually which would otherwise have been spent on energy can now be released to purchase other goods and services – without a reduction in access to energy – therefore clearly a boost to growth.
If current prices persist for the next six months, this would account for an increase in growth in a range of 1/2 to 3/4% across Europe, US, Japan, China and Latin America. Passing on the benefits leads to more competition, if we consider that 70% of cheaper oil prices can be passed on to the consumer.
No doubt climate policy will be used as an excuse to soak up the benefits, and while there are many alternative energy sources including shale, tar sands and deepwater exploration, these are expensive ways to extract oil, and considerably less viable if oil remains below $70.
As has already been suggested, the Saudis can move the price – a deliberate ploy then to reduce such investment – but they would still be in a position to maintain market share at around $60-70. It could also be said, however, that the Saudis will have done more for worldwide consumer recovery than any amount of QE has ever done, by putting money into pockets to drive growth – far more than Bernanke ever did. But when $100 was tolerable barely six months ago, how long will it be before governments levy more taxes in order to fund budget deficits?
Something though that not too much has been made of yet is the effect of, say, another six months of sustained low prices.
As revenues to OPEC nations would normally be recycled back into European and US stocks and bonds, the ensuing decline in foreign demand as such will likely take the edge off the boom – and give a bit of a nudge to US interest rates.
And on that note, I’ll leave you with the old classic … Oil be home for Christmas
