Our Opinion: 2016

Oil prices: lower for longer

The oil price has today fallen below $28 a barrel amid fears the lifting of Western sanctions on Iran could worsen the existing oversupply problem. Oil prices have now fallen by more than 70% in the past 15 months.

OPEC (the Orgaziation of the petroleum Exporting Countries) is thought to be producing record levels of around 31.5 million barrels per day, but has still lost share to non-OPEC countries in recent years, including Russia, America and Brazil. Within OPEC, the cartel is also grappling with Iraq pumping at record levels and the prospect of Iran upping its own production, now that sanctions against the country have been lifted.

The Saudi strategy is to flood the market, depress prices, testing the new entrants.

Russia has held its nerve, producing 10 million barrels per day in November, close to a post-Soviet record. But America is starting to buckle. American shale producers need a price of around $60 per barrel to break even, and activity is being cut back. The Baker Hughes rig count, which looks at the number of oil rigs active in America, has fallen to 737, the lowest since 1999. That compares to over 2,000 in mid-2008, when oil was trading at $140 per barrel. The New York Time recently concluded that current prices make “drilling and completing wells a losing proposition in almost all oil fields around the country.”

There are parallels with the oil market from 1997 to 1999, when Venezuela emerged as a major new producer. Back then too, Saudi Arabia responded by flooding the market, just as the Asian crisis kicked off, sending prices below $10 per barrel. OPEC survived that crisis and saw prices rebound to $150 per barrel. If the parallels hold, markets could be in for a wild ride.

OPEC has scrapped its production ceiling and, for now at least, seems determined to keep pumping until it has sunk American shale producers.

Iran’s deputy oil minister has said there was “absolutely no chance” that Iran will delay its planned increase in oil exports now that Western sanctions are lifted.

To cap it all, a cease fire may be taking shape in Libya. If Libyan production can go back up, the price effect will be significant. Its output has dwindled to around 375,000 barrels a day from 1.6 million before the civil war began in 2011.

Even without Libya, OPEC’s supply is likely to rise by a million barrels a day this year, according to Morgan Stanley, creating a glut that will certainly remain until year end.

Nasdaq energy analysit, Tamar Essner, says that “Given these fundamentals, and the “very nervous” market, I think it would be risky to rule out a $20 handle on oil.”

Whatever happens in the next few weeks, the upshot remains that the path of least resistance is lower for longer. Predictions of a rebound in 2017 should also be treated with caution. History shows that oil bear markets can be protracted affairs.

Low oil prices gives a real boost to nations without oil of their own, but extremely damaging to others. Middle East stock markets, for instance, continue to decline. It is important that investment strategies are reviewed to make sure they benefit from prices being lower for longer, rather than punished by it.