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You are here : IndiaNotes >> Market Action >> Commodities >> Brent Crude Oil

Oil Sector Global Outlook 2016 - Part 1

Namrata Shah | 23 Dec, 2015  | Follow Author | Add to my Favourites 
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Oil Prices


Prices of any commodity are majorly driven by its demand and supply. So, Crude oil prices are driven by demand for petroleum products (crude extracted product) and supply of crude oil (production or extraction of crude oil).


However, in case of crude oil, prices are impacted by political and economic events in addition to demand and supply of crude oil. The impact of different political and economic events on oil prices over last 4 decades is highlighted in graph below. In 2015, excess of supply along with falling crude demand has led to drastic fall in oil prices.



Crude prices are measured as 2 Brent crude and West Texas Intermediate (WTI) crude.


Brent refers to oil from North Sea fields. WTI refers to oil explored from US wells. WTI crude is lighter and sweeter than Brent crude, thereby makes it ideal crude for refining into diesel, gasoline and other products. WTI is expensive to ship to different part of the world.


As of Dec 19, 2015 - spot price of WTI Crude Oil (Nymex) is $34.55 / bbl and Brent Crude (ICE) is $36.88/bbl.


In the WTI - Brent graph (below), we see steep downward trend on oil price during last 2 years. Oil prices peak in Jun 2014 to $105.79 / bbl for WTI and $111.8/bbl for Brent and reached its low in Dec 2015. As per Citigroup, crude oil prices may fall into $20s in 2016.


With removal of ban on oil export by United States, the spread between WTI and Brent is likely to fall and remain narrow. However, raise in US interest rate would make USD denominated oil costlier. However, spread between WTI and Brent collapsed on Dec 22, 2015 with both crude were trading at $36.33. Considering the premium quality of WTI, there is a possibility of WTI quoting at premium to Brent.



Major factors driving oil prices


- With US Shale production, US was able to meet much of its consumption demand and thereby, could lower its dependence on OPEC, especially Saudi Arabia.


- In Asia Pacific region, China is major importer of crude oil. However, with slowdown in its manufacturing activities, the demand for crude oil has fallen.


- Additionally, slowdown in China has impacted its trade partner Japan's demand for oil.


- Saudi Arabia (major player in OPEC) continued to maintain its production targets even though import demand from US has fallen in order to retain market share.


- With Iran’s re-entry, supply of crude oil from Iran is expected to add to existing oversaturated oil market. 


- According to Baker Hughes data, the US operational rig count has fallen drastically in 2015 over 2014. This indicates lower drilling activities in 2015. But, US oil production continued to increase during 1H/2015. This slow production adjustment further deepened oil prices.



- In 3Q/2015, major upstream companies like ConocoPhillips and Chevron has declared their plans to cut Capex in 2016 as oil prices are falling. Lower capex would led to lower drilling activities in future, which in-turn would led to lower oil production thereby correcting demand - supply mismatch. This may put some upwards pressure on crude prices.


Cost of Extraction Oil




- In Middle East oil is extracted from onshore well, so most of the OPEC middle east countries namely Saudi Arabia, UAE have lower cost of extracting oil.


- In US, most of the drilling activities are in deepwater offshore or in form of shale gas. Both these oil reserve exploration have high extraction cost.


- Current crude oil price of around $35/bbl is much lower than breakeven cost of extracting oil from shale reservoir and deepwater fields. So, these activities would become unviable for US. On the other hand, Saudi Arabia cost of extraction is lower than prevailing crude oil price. So, Saudi Arabia does not face gross loss in oil extraction.


- As price falls, production decline is expected among most of non-opec countries. As these countries have high extraction cost compare to current crude prices.


Oil Production & Supply 



Analyzing 3 major producers - United States, Saudi Arabia and Russia, and new entrant Iran


United States


- During 2011 - 2014, technological boom in oil sector enabled US oil & gas producers to devise technique to unlock oil from shale rock.


- Further, technological innovation (hydraulic fracturing technique) has made extracting oil from non-accessible areas possible.


- So many US companies began investing heavily in new technology and production increased.


Impact of low oil prices


- Cost of extracting oil from shale gas is around $60/bbl


- Oil price have persistently remained at low levels in 2015. This has caused US shale driller to slash their spending on capex.


- Further, on account of low prices, count of operational rig has fallen and thereby number of workers employed in this sector has lowered.


Future Outlook for US


- With lifting of ban on US oil export, US has incentive to increase its production and export oil to its trade partner. However, US would prefer to undertake additional oil production only if crude oil prices are higher than its breakeven level.


- OPEC's decision to maintain its production, in its recent meeting has increased pressure on US shale drillers to cut their high cost crude production


- US domestic production has increased from 5mn bbl/day in 2008 to almost 10 mnbbl/ day in 2015. As a result, Saudi, Nigeria and Algeria for whom US was importing crude oil are now forced to look for alternative market. Now, all these countries are competing for share in Asian markets. If competition intensifies then they would be forced to offer discounts and thereby lower oil prices.


- Persistent fall in oil prices has indirectly affected US economy as whole. Upstream companies facing cash crunch has laid off number of employees. This has lowered disposable income and thereby consumption spending.


Saudi Arabia


- Saudi Arabia has 11 -12% of world oil reserves (highest) and it is largest oil producer.


- In OPEC meeting on Dec 4, 2015, Saudi Arabia decided that it would maintain its effective output at 30.0mnbbl/ day with objective to retain its market share.


- However, this strategy has also created cracks with OPEC cartel members. As not all OPEC members have onshore oil deposits to be extracted at low cost. Countries like Venezuela have high extraction cost.


 


The graph explains that Saudi has been very slow in adjusting its oil production with fall in price. Whereas, Iraq continue to increase its daily production in-spite of drastic fall in crude prices.


The supposedly reason for Saudi Arabia and Iraq's decision not to lower production could be that lower oil prices would force high cost producer like Brazil, Russia and Canada to reduce or decline its production and this would give opportunity to Saudi Arabia and OPEC cartel to increase its market share.


Russia


- OPEC decisionnot to lower its daily production is pushing crude oil prices down. The prices have now fallen to below breakeven cost for Russia.


- But, Russia continues to maintain its daily production. It derives about 50% its revenue from export of oil & gas.


- With fall in oil prices over 2014 and 2015, Russian currency ruble has significantly lost its value against US dollar and Euro.

 

- Geographically, the cold climate requires Russia to use different technology for oil extraction. As a result, Russia takes much longer to shut down and restart oil production compare to other Middle East countries that enjoys onshore oil reserves and can quickly switch production.


- So, there is very less likelihood that Russia may cut its production. If under worst scenario Russia cuts its production, Saudi Arabia and other OPEC countries would be greatest beneficiary. 


- Russia was major exporter to European countries, with almost 70% market share. However, Saudi Arabia has entered into Europe to gain market share. This will intensify competition between two countries.


Iran


- US lifted ban on Iran oil in mid-2015. Now, Iran can freely increase its production and encourage investment in oil & gas sector to revive its economy.


- Iran plans to increase its production to 2.3 million barrel of oil per day at earliest from Jul 2015 production level of 1.2 million barrels of oil per day.


- In 2012, US imposed ban on export of oil from Iran. To ensure that oil wells are not damaged by abruptreductionof oil production, Iran continued with its production and stored all excess crude oil in onshore tanks. With ban on, its exports kept falling and Iran kept filling oil tankers. By early 2015, it filled up 50 - 60 million barrels of crude oil.


- Although, Iran has tankers of crude oil ready for export, it is entering export market after long time. Iran will have to incentivize its buyers by offering discount or lowering price.


- However, to continue with its oil production, Iran need to invest heavily in its oil exploration. However, if it is unable to attract investment then Iran would not be able to increase its export.


Oil Supply Outlook for 2016


It is likely that current scenario of oil oversupply will continue in 2016. OPEC would continue to maintain its high production, as it refused to put quota on its daily oil production during its recent meeting. Continued decline in US drilling rigs and unviable fields’ exploration activities is likely to reduce US oil production. 


Russian producers are favoring field developments activities to boost oil output in the near term. With ruble’s depreciation and Russia’s oil taxation system, the impact of lower oil prices are neutralized.


Many countries has slashed investment in oil exploration activities, this will reduce oil production thereby increasing oil prices.


Part 2 of this article focuses on Oil Demand, United States and US Oil demand outlook for 2016, China and China Oil Demand Outlook for 2016, Japan and Japan Oil Demand Outlook for 2016, India and India Oil Demand Outlook for 2016, and Global Oil Outlook for 2016. Readers can find it here.

 

Source: OPEC Monthly report, Bloomberg, Thomson Reuters, World Oil, US Energy Information Administration, Market Realist

 




About Namrata Shah

Namrata Shah is a Chartered Accountant and an independent finance blogger. She loves analyzing companies financials, business models, corporate governance and other aspects of the companies. She has rich experience in research, valuation and audit, assurance & advisory function in reputed organisations. She blogs at http://finance-nams.blogspot.in/ .

 

For more information please write in to [email protected]

Disclaimer: The author has taken due care and caution to compile and analyse the data. The opinions expressed above are only the views of the author, and not a recommendation to buy or sell. Neither the author nor IndiaNotes.com accept any liability whatsoever arising from the use of any of the above contents.




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