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Oil off The Boil

April 2015

Pain of low oil price may persist

Crude oil prices have been continuing to trend lower this year, averaging $47.54/bbl in January 2015 and the decline, in percentage terms, translates to more than 55 percent since June 2014. The speed of the decline is partly attributed to unexpected demand weakness in some major economies, in particular emerging economies and the last three months witnessed a free fall in crude oil prices (see Oil Price Movement)

Overflowing Supply

The fall in oil prices in the last six months is significantly similar with the 1985/86 episode, as the cause for decline in both the cases was overflowing supply of crude oil. Between 1984-2013, episodes of oil price declines of more than 30 percent in a six-month time frame occurred, mostly coinciding with major setbacks in the global economy such as US recessions (1990-91 and 2001); the Asian crisis (1997-98); and the global financial crisis (2007-09).

There have been only three occasions since 1984 when the price of oil dropped by 60 percent or more in any seven-month period. First, during 1985-86, when the West Texas Intermediate nearby futures contract (WTI was the world oil price barometer at that time) declined by 67 percent from $31.72/bbl (November 20, 1985) to 10.42/bbl (March 31, 1986).

Second, in 2008, when Brent nearby futures contract (today’s world price indicator) declined by 75 percent from $146.08/bbl (July 3, 2008) to $36.61/bbl (December24, 2008).

Third, during 2014-15, when the Brent nearby futures contract declined by 60 percent from 115.06/bbl (June 9, 2014) to 46.77/bbl (January13, 2015). The current oil price drop is the third largest 7-month decline of the past three decades — only the 67 percent drop from November 1985 to March 1986 and the 75 percent drop from July to December 2008 were larger.

The graph (see Crude Oil) illustrates the zig-zag movement of crude oil prices from a low of $50 to a high of $140 in the last ten years and the clock has turned full circle with the crude oil price of Jan 2015 touching the Jan-2005 level.

Oil Futures Edge Lower

Oil Futures Edge LowerThe oil futures market witnessed active trading in January 2015. Crude oil futures prices continued their downward trajectory over the previous month driven by glut in oil supplies and sluggish demand, with both Nymex WTI and ICE Brent ending below $50/bbl for the first time in five-and-a-half years.

ICE Brent settled down at $49.76/bbl for Jan 2015, while Nymex WTI lost $11.96/bbl to finish the month at an average of $47.33/bbl. Over the month, the benchmarks declined by a massive 21% and 20%, respectively. ICE Brent and NymexWTI lost nearly 60% of their values since their peak in June 2014.

Moreover, compared with 2014, Nymex WTI and Brent kicked off in Jan 2015 at $47.53 and $57.35 from $94.86/bbl and $107.11/bbl in January 2014, respectively.

On February 6, 2015, ICE Brent stood at $57.80/bbl and Nymex WTI at $51.69/bbl. Investors continued to bet on a rebound in oil prices. ICE Brent net long positions increased 27,468 to 143,039 contracts during the final week in January, according to figures from the ICE Futures Europe exchange.

Speculators were also bullish on the rising US crude oil market, increasing net long positions by 16,937 contracts over the month. Net long US crude futures and options positions during the month increased to 216,325 lots as per the US Commodity Futures Trading Commission (CFTC) data. Total futures and options open interest volume in the two markets increased in January 2015 by 543,889 contracts to 5.14 million lots.

The daily average traded volume during January 2015 for Nymex WTI contracts increased sharply by 183,929 lots to average 825,682 contracts. ICE Brent daily traded volume also rose by 237,827 contracts to 834,344 lots. The daily aggregate traded volume in both crude oil futures markets increased by 421,757 contracts, up 34%, to around 1.66 million futures contracts, equivalent to around 1.7 billion barrels of oil per day. The total traded volume in Nymex WTI and ICE Brent was up sharply at 16.51 million lots and 17.52 million contracts, respectively, over the month.

Growth And Oil Demand

The International Monetary Fund (IMF) revised downwards its global growth forecast by 0.3 percentage points (pp) for both 2015 and 2016 at 3.5 percent and 3.7 percent respectively, as positive effects from lower oil prices are being counter-balanced by weak investment.

Growth expectations for emerging markets have been cut by 0.6 pp; Russia’s economy is expected to shrink by 3.5% this year, while China’s growth is expected to fall below 7%, the weakest growth figure in more than two decades. According to Oil Monthly Market Review of IEA, for the year 2015, world oil demand is projected to rise by 1.17 mb/d mainly to reflect expectations of an uptick in oil requirements in OECD Americas. In 2015, non-OPEC oil supply is projected to grow by 0.85 mb/d, down 0.42 mb/d from the previous assessment. OPEC NGLs are forecast to grow by 0.20 mb/d to 6.03 mb/d in 2015. In January, OPEC crude production decreased by 53 tb/d to average 30.15 mb/d. Estimates suggest that a 30 percent oil price decline could increase global GDP by up to 0.5 percent. However, both cyclical and structural factors might affect the impact of oil price drop on growth in 2015-16.

According to a World Bank study, low oil prices have already led investors to reassess growth prospects of oil-exporting countries. This has contributed to capital outflows, reserve losses, sharp depreciation of currency in many oil-exporting countries including Russia, Venezuela, Columbia, Nigeria, and Angola. Financial strains could imply adverse spill-over effects for partner economies, through trade and financial linkages, including remittance flows.

Demand-Supply Dynamics

Global oil demand in 2015 is currently expected to rise by 1.17 mb/d. As prices drop, oil requirements are likely to respond positively, although this can be impacted by other country-specific factors. For example, in 2008, prices fell sharply with the onset of the financial crisis and the global economic recession, which led to deterioration in demand. This time the sharp fall in prices has been mainly driven by excess supply. As a result, lower prices are likely to help to accelerate the pace of oil demand growth this time.

On the supply side, despite the fact that the costs of extracting unconventional oil may be above current oil prices, because most of these costs are sunk, it will take at least a year before supply moderates. On the demand side, the International Energy Agency expects further weakening, with oil consumption projected to average 93.3 mb/d in 2015, according to the January 2015 assessment, down from 94.1 mb/d in July 2014. Crude oil inventories continue to rise, particularly in the US where crude stocks are at record highs, and product stocks are at near-record levels.

Middle East oil demand is dependent on the performance of the various economies in the region with the impact of lower oil prices on their spending plans. For 2014, Middle East oil demand growth was expected to hover around 0.25 mb/d, while oil demand in 2015 is projected to grow by 0.29 mb/d.

OPEC’s Policy Change

OPEC traditionally influenced the oil prices by adjusting its oil supply and acted as the global oil market’s swing producer to stabilize prices within the desired price range (set to $100-110/bbl during 2011-14). This targeting of an oil price band dramatically reversed course on November 27, 2014, when OPEC decided to focus on preserving its market share instead by maintaining its production level of 30 mb/d. The change in policy implies that OPEC may no longer act as the swing oil producer.

Price Outlook

The interplay of demand and supply will drive the price up and down in the coming months and the nominal oil prices are expected to average $53/bbl in 2015, 45 percent lower than 2014, according to the forecast of the World Bank. However, it is common knowledge that several OPEC and non‐OPEC oil producers rely heavily on oil revenues to finance their fiscal budgets.

If crude oil prices continue to trade in a less than expected price climate, the oil‐dependent producers will have to make tough decisions which could potentially force some countries to plug the supply flow to drive the price up. Potential new supply disruptions cannot be ruled out in a lower price scenario and present an uncertainty in the oil price forecast.

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