14 October 2014

The Impact of Falling Oil Prices

Oil prices have continued to trend downwards in recent weeks and there are many indications that suggest that oil prices will continue to trend downwards in the months ahead.  While ISA is not forecasting a collapse in oil prices at any time in the coming years, we do expect oil prices to fall towards $80 a barrel (West Texas Intermediate) and $85 a barrel (Brent Crude) by the end of 2014.  However, there are a number of factors that could result in oil prices remaining lower for a prolonged period of time, and, if this were to occur, there would be major ramifications for many of the world’s leading oil producing countries and the oil industry.

Just a few months ago, oil prices were approaching $110 a barrel due to the threat of major disruptions to oil supplies in key oil producing countries as well as a more optimistic outlook for many of the world’s leading economies.  However, despite the conflicts underway inside, or involving, many key oil producing countries such as Iraq, Libya and Russia, supply disruptions have not been a major factor thus far.  In fact, the surge in oil output in the United States has led to a major increase in oil supplies and reduced the demand for oil exports to the US.  Meanwhile, the economic outlook for key oil markets such as Europe, China and Japan has worsened in recent months, leading to fears that supplies will continue to rise at a time when demand will remain very sluggish.

These factors, combined with the apparent willingness of Saudi Arabia and other OPEC members to accept lower oil prices, suggest that lower oil prices are here to stay for the foreseeable future.  With the United States producing more oil and with Saudi Arabia maintaining its oil output levels, there will be less fear of any supply side problems.  In the meantime, the economic outlook for regions such as Europe and China call for lower growth rates lasting into 2015, with European demand remaining stagnant in the coming years and with Chinese demand not growing as fast as had been expected.  As a result, oil prices are likely to hover around $80 a barrel in the coming months, and, barring a major supply side disruption, will not rise above $90 over the next six to nine months, if not longer.

These lower prices are certain to have an impact on many of the world’s leading oil producing countries.  For example, Russia is set to suffer a major economic crisis as it costs $80 a barrel to produce oil in that country and its economy is already being battered by Western sanctions put in place in the wake of the war in Ukraine.  Likewise, Venezuela’s economy is already battling hyper-inflation and severe product shortages and can ill afford to deal with lower oil prices as oil exports are the only source of foreign earnings for that country’s economy.  Meanwhile, many of the more unconventional oil exploration and production projects underway in the world (Canada’s oil sands, Brazil’s ultra-deepwater project, etc.) require higher oil prices to be profitable.  If lower prices persist, many of these projects could be put on hold until prices return to higher levels.  However, until global demand rises, oil prices are likely to hover near $80 a barrel and this will have a massive impact on the global oil industry.