In the summer of 2014 crude oil cost $105 per barrel, it is 2016 now and a barrel of crude oil costs around $40. This is a near 60% drop in oil prices over the two years. Low crude oil prices are causing many firms to stop production at their oil rigs since the low prices are not even covering operating costs.
Theories such as Saudi Arabia trying to drive out shale producers from the market or that the slow down in China has caused oil prices to collapse have been proposed.Using data from the U.S. Energy Information Administration and the OPEC annual reports, let us look at which of these theories actually hold.
Analysis of the global crude oil market
Let us break up this analysis of the crude oil market into three parts, USA, OPEC and finally World.
United States of America:
The United States has the worlds largest deposits of shale oil. Over the past few years, technological advancement has made the extraction of shale oil commercially viable. This has lead to a rapid rise in the production of shale oil in the United States. Shale oil is after all a perfect substitute for crude oil, thus, production of shale oil ultimately leads to a rise in the supply of crude oil.
Looking at data for crude oil production, the supply of crude oil has gone up from 9.69 million barrels per day in 2010 to 15.04 million barrels per day in 2015. Thus, the supply of crude oil has increased by 55% between 2010 and 2015.
Now looking at the demand side, the consumption of crude oil in the United States has increased from 19.18 million barrels per day in 2010 to 19.40 million barrels per day in 2015. Thus, the demand for crude oil has only increased by 1% between 2010 and 2015.
Thus, there has been a huge increase in the supply of crude oil in the United States which has not been matched by a corresponding increase in the demand for crude oil.
This increase in supply of crude oil has led to a reduction in the import demand for it, the import of crude oil has fallen from 9.49 million barrels per day in 2010 to 4.36 million barrels per day in 2015, this is a fall of 54%.
Thus, the countries which were previously supplying crude oil to the U.S. have to now look for alternative markets.
The OPEC or the Organization of Petroleum Exporting Countries consists of Algeria, Angola, Ecuador, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela. This bloc of countries was formed in 1960 with the purposes of greater coordination among oil producing countries. This oil producing cartel is the worlds largest oil supplying bloc, hence, they hold a vast amount of market power. OPEC countries generally have the most efficient oil rigs, hence, they can produce at very low costs. Thus, it is very easy for them to reduce prices to clear markets.
Looking at the data for the OPEC countries, in 2010, OPEC produced 36.76 million barrels of crude oil per day, while in 2015, they produced 38.18 million barrels of crude oil per day. Thus, the supply of crude oil increased by 3.8% in the given period.
Now taking the demand side, in 2010, OPEC consumed 7.99 million barrels of crude oil per day, while in 2015, it consumed 8.22 million barrels of crude oil per day. Thus, the consumption of crude oil increased by 2.8%.
Total exports by OPEC countries grew from 28.77 million barrels of crude oil per day in 2010 to 29.96 million barrels of crude oil per day. Thus, exports by the OPEC increased by 4.1% in the given time period.
Therefore, far from reducing the volume of production by the amount which they are now unable to sell to the United States, the OPEC countries have actually increased the amount they produce and supply to the world market. Thus, further increasing the supply of crude oil in the world market.
Now let us look at the crude oil market as a whole.
Taking data for the entire world, the production of crude oil increased from 88.08 million barrels per day in 2010 to 95.74 million barrels per day in 2015. Thus, the global supply of crude oil rose by 8.6% in the given time period.
Looking at the demand side, the global demand for crude oil increased from 88.2 million barrels per day in 2010 to 93.70 million barrels per day in 2015. Thus, global demand increased by 6.2% in the given time period.
Additionally, it can be seen in the above data that there is actually an excess supply of oil in the world market at the end of 2015 versus an excess demand of oil in the world market in 2010.
Summing up all the above data:
After looking at all the above data, we can conclude that the main reason for the fall in global oil prices is the increase in supply by the United States which hasn’t been matched by a corresponding increase in demand.
The OPEC countries which generally cut production in such times to keep crude oil prices elevated have for some reason refrained from doing so. Probably the mood of OPEC is best summed up by what the Saudi Arabian oil minister Ali Naimi said in a recent interview:
“First of all, why did we decide not to reduce production? I will tell you why. Is it reasonable for a highly efficient producer to reduce output, while the producer of poor efficiency continues to produce? That is crooked logic. If I reduce, what happens to my market share? The price will go up and the Russians, the Brazilians, US shale oil producers will take my share.”
Thus, it looks highly unlikely that OPEC countries will cut the supply of oil fearing loss of market share to the countries stated above.
Blaming the fall in oil prices on the slow down in China where the demand for oil has risen by 25% between 2010 and 2015 would be absolutely wrong.
As can be seen from the global supply and demand data, there exists an excess supply in the global crude oil market even at the end on 2015, thus, prices are likely to fall further.
Iran: What lies ahead?
In addition to all the above points, the trade sanctions on Iran were lifted in January of 2016, this would only make the oversupply situation worse. Iran would by no means be happy to sit out and sell no oil, the trade sanctions have crippled the country’s economy and they would like to regain their previous market share as soon as possible. To this effect, Iran would be more than willing to cut prices and sell their crude oil. But, we will only know about this in due time.
As of 12th March 2016, Brent Crude prices stand at $40.39 per barrel, having risen from a multiyear low of $27.10 on 20th January 2016. But, this price rise has been mainly on the back of speculative buying of crude oil in the hope that prices will start rising, in reality, the fundamentals of the market haven’t changed much. Thus, this price of $40 may not sustain for long.
Oil is coming off a commodity super cycle which has lasted for nearly 12 years. Generally, it has been observed that after such a super cycle, prices of such commodities remain benign for a period of around 10 years. Whether or not this will be the case for oil will be seen over the next few months and years. But the world is full of surprises, after all three years ago, who would have thought that we would see crude oil prices falling to below $30 a barrel.