First oil

“There need not be a conspiracy, just a convergence of economic and political interests.”—Jonah Goldberg, American Enterprise Institute.

Viewed strictly from a supply-demand perspective, the crude oil price decline is a simple, black-and-white issue. The global oil market now has an oversupply of about 2 MMbopd. Once this deficit is erased, the oil prices should start edging up. When you dig deeper, however, you encounter more than fifty shades of grey in terms of actions, reactions and motivations of the major actors in this unfolding drama.

What is the Saudi end game? Saudi Arabian Oil Minister Ali Al-Naimi, the architect of the price collapse, has made it clear that the Saudis want to protect their market share. According to an analysis conducted by World Oil Executive Editor Kurt Abraham, the Saudi market share peaked at 18.91% in 1991, and has stalled out at 12.6% since 2012. The biggest encroacher of Saudi market share has been the United States, which has increased its market share from 6.8% in 2010 to 10.9% in 2014. While the Saudi action is targeted at the U.S. shale oil producers, the Kingdom does not mind that collateral damage affects Russia and Iran. The Saudis object to Russia’s support of Syria’s Bashar al-Assad regime, and their enmity against Iran has its origin in the ancient, Islamic Shia-Sunni schism. The question remains as to what the Saudis hope to gain by preserving market share at half the price of oil. Once the oil price recovers above $60/bbl, international competition will be back to reclaim its market share.

Obama’s gain every which way. In his State of the Union address on Jan. 20, U.S. President Barack Obama said, “We are as free from the grip of foreign oil as we’ve been in almost 30 years,” claiming credit for growth in crude oil production from the shale plays on private and state lands. Further into the address, Obama said, “And thanks to lower gas prices and higher fuel standards, the typical family this year should save about $750 at the pump.” Lower gasoline prices are good for the typical consumer, but are causing economic hardship for the shale producers. Eventually, U.S. crude oil production will start declining, and the country will be forced to increase imports of foreign oil. What will Obama say then?

Cutting to the bone. In response to the drastic drop in crude oil prices, both operators and service companies are announcing budget reductions and employee layoffs. Just within the service companies, the announced layoffs amount to 25,000. BP’s case is even more drastic. After the Macondo spill claims started making their impact, the company sold many of its fields, including the Permian basin assets, which it had inherited through the Amoco acquisition. As such, BP lost out on the last Permian boom. In late January, BP surrendered its operatorship of Gila, Tiber and Gibson fields in the deepwater Gulf of Mexico, and promptly laid off employees, who had been working on these assets. When the business turns around, how many of those who were laid off last month will want to return?

Contango and commodity speculation. The major players in the oil markets are the commodity traders, whose future expectations determine the oil prices. At this time, we have a situation termed “contango,” where future prices of a commodity are higher than the current spot prices. As such, some heavyweight traders are storing vast amounts of crude oil on the seas in very large crude carriers, in the hope of an escalation in prices. Of course, it is a high-risk game, with the possibility of making exponential gains or getting wiped out.

Only shades of grey. Few can predict how the oil and gas industry will fare over the next months. Citigroup has suggested recently that oil inventories are so high, that prices may drop to $20/bbl. On the other hand, some OPEC leaders expect the price to rebound to $120/bbl within months. Until stability returns to the oil markets, there will only be shades of grey to ponder. 

About the Authors

Pramod Kulkarni

World Oil

Pramod Kulkarni pramod.kulkarni@worldoil.com