Oil – the good, the bad and the ugly
The price of oil may only be something you think about when you’re filling up at a petrol station or when you book a flight and see fuel excises. But if you’ve been looking at oil prices recently, you would have noticed they’ve been going down. So what does this mean for investments?
In this article, we explore the reasons for this fall in pricing and the outlook for oil markets.
Declining oil prices
Oil prices have changed rapidly in the past year. This has been a result of two factors – global oil supply and demand, and the Organisation of the Petroleum Exporting Countries (OPEC).
Key points
- Oil prices have declined over the past year due to:
- increased supply, while demand remained static
- OPEC allowing the market to self-regulate supply.
- Lower prices may benefit consumers and countries that import oil, while posing challenges to economies that rely on oil exports.
1. Global oil supply and demand
- Growth in oil demand has been at a stable pace with growth and projected growth at approximately 1.2% pa for 2004-2019.
- In recent times, there has been a dramatic increase in supply with shale oil as the new source of oil. Much of the increase in production has come from the US. The increased supply has meant an excess of oil and in turn, prices have declined.
2. OPEC
- OPEC has regulated oil over the past 30 years by matching supply to demand. This meant the level of prices encouraged development of new sources of oil.
- Shale oil is cheaper to produce than other sources of oil and as a result, was still profitable even at much lower prices. This meant OPEC had less power to regulate the market by restricting or increasing production.
- OPEC is now allowing the market to self-regulate through lower prices, and the current levels are now not profitable for the majority of US shale oil producers.
What do lower oil prices mean?
Lower oil prices are particularly helpful to consumers but can also be positive for some countries.
- Cheaper oil prices flow on to cheaper energy prices both for homes and for food production, as well as cheaper petrol prices, leaving consumers with a higher disposable income, particularly beneficial to those in countries with lower average incomes.
- Countries that import oil can now acquire the same volumes more cheaply which assists with growth. Europe and Japan fall into this category which will assist with their economic recovery.
In contrast, countries that rely on oil and gas exports will face economic pressure due to the lower prices.
- Some of the most dependent countries include those in less stable global regions like Nigeria, Libya, Russia and Iran.
- Increased economic pressure may also heighten existing tensions in these regions.
The outlook for oil prices
The new low threshold for oil prices is around US$65 per barrel, compared to around US$80 per barrel up until November 2014. If prices drop below this level, it would discourage new shale oil development, and production has already decreased with US rig counts dropping by approximately 20% since mid-2014.
Lower supplies will help drive the market to correct to higher oil prices. Prices closer to US$80-US$100 per barrel over the next 5-10 years is required to ensure current oil consumption is being replaced by new discoveries. So perhaps we should enjoy our cheaper petrol while we can.
