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Why Oil Prices Remain Weak

As one of the top five global economic risks analyzed by Dun & Bradstreet’s Former Lead Economist, Bodhi Ganguli, global oil prices remain unfavourable for international oil companies (IOCs). On May 25th 2017, OPEC and non-OPEC members extended their production cuts by an additional nine months. The original production cut was introduced in late November 2016 for a period of six months. The reason for the extension is attributed to the positive results experienced from the previous quota agreement. During the previous six month period, oil prices responded favourably, with a monthly average Brent Spot remaining above USD 50/b. However, the average Brent Spot was still significantly below the level that oil-exporting countries expected. Surprisingly, following the recent quota renewal, oil prices have fallen below the USD 50/b mark. So why have oil prices fallen?

Supply is Outperforming Demand

The excess of supply has maintained a downward pressure on prices. Since October 2016, approximately 1.8m b/d have been taken out of the market; so why are prices not increasing? One reason could be attributed to the fact that countries are not as compliant as we might think. There are increasing signs that OPEC members are not adhering to the agreement. According to the International Energy Agency (IEA), OPEC compliance in June fell to 78%. However, despite recent regional disputes and geopolitical tensions, Saudi Arabia has increased its production- yet, still within quota levels. Supply was furthered heightened when Nigeria and Libya, both not part of the agreement, both increased their output sharply; production increases were made due to improvements in their geopolitical tensions. The combined output of these two countries since the end of September 2016 was over 760,000 b/d, adding to the excess global oil supply.

US Propels Production

Given this, Dun & Bradstreet predicts that oil prices will remain weak well into 2018.
 

Additionally, the US shale-oil output has increased significantly despite relatively weak oil prices. Technological advances and cost cutting have made these fields far more resilient in the face of falling oil prices; as a result, the oil rig count has grown significantly. According to Baker Hughes, in the past year, the rig count in the US has increased from 512 to 952- adding almost 1m b/d. The output of solely US, Nigeria and Libya have virtually neutralized the OPEC production cuts. It’s clear that supply remains strong, creating an imbalance in the oil market. However, how long will the US shale oil boom last? Experts say that oil prices could fall significantly before the US shale boom ends.

 

The Long-Term Effects of Low Oil Prices

The low-price environment is curtailing investment levels. According to Rystad Energy, hydrocarbon projects have been delayed at a faster rate in 2017 than in 2016; there have been more project delays in the first half of 2017 than the whole of 2016. When oil markets return to balance (where supply and demand become more closely aligned) the lack of investment over recent years will see the imbalance swing, with demand outstripping supply. This will bring a strong rebound in prices. However, only an agreement to cut production further between OPEC and non-OPEC countries would help bring markets back into balance more rapidly. With the history of OPEC deals, the issue remains one of compliance, not agreement. Given this, Dun & Bradstreet predicts that oil prices will remain weak well into 2018. We continue to monitor the interaction of oil prices, geopolitical tension, and the evolution of cross-border risks to keep our finger on the pulse of the global economy.

 

 

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