Oil prices and its consequences

Oil prices and its consequences

 
In June 2014 the price of Brent crude was up around $115 and in January 2015 it has fallen to $52. During decade oil prices were bouncing around $100 per barrel since 2010 because of soaring oil consumption in countries like China and conflicts in Iraq. Companies started production of oil from difficult to drill places.  To take advantage of high prices many companies started using state of art technology like fracking and horizontal drilling to extract oil from shale formations in North Dakota and Texas. Even Alberta’s (Canada) gooey oil sands were heated to extract usable crude. It added 4 million new barrels of oil per day since 2008. (75 million barrels of oil per day is the global oil production)

Up till now the new production of crude oil by US does not have effect on the supply. Not to forget other conflicts like civil war in Libya, Iraq conflict and sanctions on Iran. More than 3 million barrels per day production was affected because of these conflicts.

But by mid 2014 below events happens and suddenly production increased:

• Libyan crude exports rose as two key export terminals Es Sider and Ras Lanuf were resumed from disruption of rebels.
• Iraq production of oil came back online

On the contrary demand of oil decreased because of below reasons:

• Oil demand decreased in China and Germany
• USA, the world biggest oil consumer saw big cutbacks in industrial oil use after recession and increase in use of fuel efficient cars

On the other hand demand of oil decreased due in USA, Europe and Asia because of economic slowdown and switch over sustainable energy. In late 2014 the supply of oil was greater than demand and in September prices started to fall.

OPEC control prices by either cutting production or increasing production. At the crucial meeting in Vienna on November 27 countries like Venezuela and Iran wanted to control prices by reducing production in order to breakeven on their budgets.

But Saudi Arabia wanted to keep price to fall as it did not want to repeat history. In 1980, in order to control price it reduced production but Saudi Arabia lost the market share. Saudis have now decided to go for low price option as this is short term phenomenon. The government has massive foreign exchange which would helpful to finance deficits.

OPEC (world’s largest cartel) did not take any steps to reduce production. Higher oil prices were desperate for big OPEC economies like Saudi Arabia and Iran to control the budget. Saudi Arabia did not took any stringent steps to control falling crude price as it thought that it would give undue advantage to US oil boom.

Effects of falling prices on economies:

a) Russia which is highly dependent on oil and gas production with oil revenues making 45 percent of government budget will ruin the economic system in country. Many economists believe that Russia’s economy will shrink by 4.5 in 2015 if oil stayed at $60 barrel. In an attempt to stop people from selling off rubbles Russia’s central bank have increased interest rates from 10.5% to 17.5%.

b) Iran’s economy just began to recover after many years of recession. In order to balance budget Iran needs price of crude above $100 since it is much harder after western sanctions.

c) Venezuela which is highly reliant on crude sales may face potential meltdown. It is 10^th largest oil producer and accounts for 95% of its export earnings. As inflation increased up to 60%     mass anti-government protest were flared up. Scarcity of basic products is increasing including medical supplies. One of the analysts at Nomura suggested that it needed crude prices up to $200 per barrel to balance its budget