The oil price gurus are located in New York and Paris. On the one hand, the analysts at Goldman Sachs focus their attention on market trends relating to oil production and oil price while, on the other hand, the International Energy Agency IEA based in the French capital keeps an eagle eye on long-term developments. In the past, both have frequently hit the nail on the head with their forecasts and both have very recently published their short- to medium-term expectations.
For several weeks now, well-informed observers have noted to their amazement that, in spite of the armed conflicts in Iraq and the Ukraine and other geopolitical uncertainties, the price of crude has been moving in only one direction: downwards. From June to December 2014 the prices for American WTI crude and for North Sea Brent crude have fallen by more than one third. And the latest decision of energy cartel Opec on 27th of November 2014 additionally worsened the situation for oil producers. In early December 2014 the price of a barrel of WTI was US$ 64. Some days before this development, Goldman Sachs had corrected its forecast for the first quarter of 2015 to US$ 75 – the analysts had previously estimated US$ 90. IEA is also expecting a further fall in prices during the coming year.
Conspiracy Against Russia or Market Mechanism?
The underlying reasons are as complex as the consequences. The government of Russia, whose economy is hugely dependent upon oil exports as a foreign exchange earner, strongly suspects a conspiracy between the USA and the oil producers in the Middle East. However, that scenario is not particularly likely. After all, Saudi Arabia in particular recently pushed down the oil price by announcing its intention to reduce the price for US customers, whereas European and Asian customers should pay more. Although the Saudi government needs the price to stay above US$ 90 per barrel to balance its national budget, the world‘s largest oil producer fears a loss of its global market shares and is therefore prepared to live with an oil price of $ 80 in the medium term.
This is because, thanks to shale oil fracking, the USA has advanced to become a serious competitor, which is preparing to exceed the production levels of the Saudis during the coming two years.
Goldman Sachs predicts a downturn in production levels in the USA at a price of $ 75 for WTI crude. In fact, Conoco Phillips and Continental Resources, two of the leading companies in the US fracking business, have already announced their intention to reduce or discontinue their investment in exploration.
Since the production of shale oil per well drops by 20 to 50 percent per annum, the volume growth in the USA could even decrease significantly in the short term – were it not for another factor: technical advances have enabled producers to reduce production costs by a third, i.e. to a current level of $ 60 per barrel, in the course of the last five years. And the greater the price pressure, the more creative the cost-cutting measures become. While Deutsche Bank estimates that a price of $ 80 per barrel would make some 40 percent of shale oil production unprofitable, Conoco Phillips believes that it will take about a year before things get financially tight for smaller shale oil exploration companies.
Falling Raw Material Prices?
The low oil price is causing headaches not only for producers in the USA. World-wide it is also affecting other oil producing countries – above all Iran, Venezuela, Nigeria, and Russia – and increasing their national deficit. In the USA too, investors have gambled on an in-creasing oil price or at least a large difference between the price of oil and that of gas. For example, the South African company Sasol, which has planned to build a $ 16bn GTL plant for production liquid fuels from shale gas in Louisiana. However, these developments could bring some relief for the German chemical industry with its oil-based raw materials supply chain, and for which a wide price difference between natural gas and petroleum constitutes a competitive disadvantage relative to US companies. Standing at 34 percent, expenditure on raw materials represent the largest cost factor for chemical companies.
However, the German Chemical Industry Association (VCI) isn‘t expecting any major effects: „The falling oil price means that the cost of raw materials for chemical companies will drop after a slight delay. As customers of chemical companies require that such cost reductions are quickly passed on, only a short term increase in profit margins can be expected“, says Dr. Henrik Meincke, chief economist of VCI, and adds: „In the short term oil prices will not continue to fall. By the end of 2015 oil prices are expected to be higher again – at around $ 100 per barrel. In the medium term, however, we consider previously discussed extreme scenarios of far higher prices to be unlikely. Nor does the European IEA expect a rapid return to the old all-time oil price highs. However, the IEA does expect a long-term increase in demand: in 2040 a daily production level of 104 million barrels of oil will be necessary to satisfy customer demand – an increase of 15.5 percent over today‘s production level. According to the IEA, an annual investment of US$ 900bn in oil and gas exploration will be necessary to meet this target. In view of recent announcements of the multinational oil companies, this figure appears questionable. It was these companies which invested so heavily in production in the past ten years and thus contributed to the current glut of oil. In fact, almost all market leaders have meanwhile announced their intention to reduce their levels of investment.
Since June, prices for WTI and Brent crude have moved in only one direction: downwards. Moreover, leading forecasting institutes are not expecting any renewed price increase during the coming year. This disincentivises producers from investing in the exploration of new resources. However, demand will rise in the long term – and could then trigger a new „hog cycle“.
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