In July, crude oil price was around $100. Now it’s around $65. What has caused the oil price to crash 35% suddenly?
The US Benchmark Western Texas Intermediate (WTI) fell to $64.47 today which was its lowest level since May 2010. This comes after the WTI contracts for January had already crashed 10% at market close on the New York Mercantile Exchange on Friday. Why has crude oil price oil been on a relentless slide over the past four months? Normally, declines such as this are associated with fears of recession. What are the reasons this time?
US shale oil revolution: The main reason is that there is an oversupply in the oil market thanks to shale oil revolution in the US. Most people had barely heard of shale oil until a few years ago. As recently as two years ago, shale oil was being dismissed by all market participants as a sideshow. Now, shale oil production from the US has taken its oil production back to the level seen in the 80s, causing a major oil glut in the markets. This, combined with the other two factors noted below, has caused a prolonged drop in world oil prices.
OPEC holds production: Conspiracy theorists say that OPEC, the cartel of oil-producing countries wants to break the back of US shale oil companies and actually wants prices to go down. This is why in the meeting held on 27 November, OPEC countries voted to continue oil production at current levels, which stands at 30 million barrels a day.
Disregarding worries from Venezuela, Iran and Iraq, the Saudis pushed for higher production to sustain market share, and bankrupt US shale oil companies, and OPEC subsequently voted for the Saudi position. Of course, OPEC countries depend on oil exports for their economic balance and may suffer serious financial setback by selling their oil for cheaper, in the hope that they would be able to bankrupt shale producers before they bankrupt themselves. At least three OPEC members were apprehensive of fighting a war of attrition against the shale oil producers. Expert opinion on whether shale will stay viable is divided considering that the technologies and economics of shale oil are still not widely understood.
Chinese consumption slump: While the drop in oil prices is largely because of increased production by the world's largest oil consumer, the US, there is a third major factor at play. Until a few years ago, OPEC could tweak production to manage oil prices according to demand. With the slowdown in China, the oil demand itself is slowing down.
Over the last few years, China was the new market for oil that grew but no new large market seems to be on the horizon that can consume the way China did. If there is a slowing growth in the overall market, coupled by increased production by the world's largest oil consumer itself, it is anybody's guess as to how long the price wars can go on.
Falling oil prices have however been good news for India. Share prices of Indian oil marketing companies shot up as higher oil consumption is expected as a result of lower prices. An improved economic scenario, lower oil import bill and input costs have already spurred the stock markets higher. The overall result of the oil price saga will play out over the long term and for now oil importers and consumers will remain a happy bunch.
The choice facing OPEC is that it could hold production and grow the number of overall oil consumers while taking a short term fiscal beating, with the hope to drive shale oil out of the game. Or OPEC to drop production and hold prices but with the guarantee of losing market share to shale oil and almost inevitably causing long term harm to its interests.
In choosing the former, OPEC seems to have dug in for the long fight.
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