Recent events around the globe have led to record-low oil prices, reminding us just how closely the price of oil is linked to geopolitics. Brent crude has fallen 50% since last June, dropping below the US$50 per barrel benchmark today, reaching its lowest since January 2013. Analysts have identified the main causes of this drop as being both a steadily growing oversupply of oil and a decrease in its global demand.
The price decrease caused by the supply side is a result of both real situations and speculation. In a classical game of prisoner’s dilemma, oil companies have been increasing production and the US is just one of the many players that contributed to last month’s 21% decline in the price of oil. Last year, the US became the world’s main oil producer thanks to the shale boom which allowed for an impressive increase in output. IHS Energy reported current production levels to be 9 million b/d higher than they should be for the supply and demand balance to equalize. Responding to current unfavorable oil prices, the US has taken a strategic decision to close many oil rigs, keeping only the best performing ones. In spite of this, there are no signs of a decrease in production, although it is important to note that Obama’s new Clean Power Plan announced on Monday favors renewables over America’s sweetheart, shale oil. The Organization of the Petroleum Exporting Countries (OPEC) also played its turn, boosting production to the highest levels in recent history. Bloomberg reported OPEC’s crude oil production to have reached 32.1 million b/d in July 2015, surpassing its output quota by 2.1 million b/d. This excess production is the result of a strategic decision taken by certain OPEC members, including Saudi Arabia, to eliminate the growing production from more costly shale oil and gas projects and attempt to increase global demand through lower prices.
Adding to the turmoil of global oversupply is the possible and probable opening of Iran’s oil industry to international markets. This would come after the signing of a prospective nuclear pact, which will remove sanctions on Iran’s oil production while attracting new investment. The country announced that its oil production could double post-agreement, a declaration which has already impacted the global oil prices to reflect deepening oversupply. Iran’s Oil Minister, Bijan Zanganeh, said the country would return to the level of 3.8-3.9 million b/d in matter of months, although analysts estimate it would take until 2016 before it returns to full-scale oil production. In any case, more oil can only mean bad news for the oil price unless demand keeps up.
Unfortunately, this seems doubtful in the current state of affairs. Economies across the world are slowing down and thus decreasing their demand for energy. Recent data suggests that Chinese manufacturing has fallen to a two-year low, with the official Purchasing Manager’s Index (PMI) dropping to 50. China, being the world’s second biggest oil-consumer, played a large role during the past decade in keeping oil prices high, and a further economic downturn would be troublesome, to say the least, for oil producers. Caixin, a private economic indicator on Chinese manufacturing, explains that this unexpected slowdown is due to falls in both total new work and new export orders, leading manufacturers to promptly cut production. To make matters worse, the country also saw its stock exchange drop by 8% at the end of July, the worst fall since 2008. Nevertheless, China does come bearing some good news. Increasing oil demand from consumers is somewhat offsetting weak industry demand. The rest of the BRIC countries are also experiencing a deceleration in their economies, further reducing oil demand. In fact, the forecast for the rest of the world is not positive either; the IMF revised its global growth figure from 3.5% in 2015 to 3.3% in its most recent World Economic Outlook.
Is there any hope? It is hard to tell. Both experts and Saudi Arabia share the view that low prices will lead to increased demand, which in turn will push oil prices back up. Although this idea makes sense, an important variable has been left out from the analysis, namely the consumer’s propensity to save. Indeed, oil prices have already decreased, impacting gasoline prices, and yet there is no sign of greater consumer spending. To the surprise of investors, the extra money is being saved. If the previous strategy falls through, the only organization that might be able to change the game would be OPEC. This may prove difficult, as its golden days seem to be over. Previously, most significant players in the oil market were part of the organization or followed its production quotas, allowing OPEC to function as an oligopoly and control oil prices. The recent arrival of non-traditional producers, like oil sands firms and shale oil firms, is reorganizing the industry, reducing OPEC’s level of influence despite its 40% market share. As stated earlier, all players in the oil and gas industry are stuck in a game of prisoner’s dilemma and OPEC is no exception. The model predicts all players will default and continue pumping as much as they can and, indeed, that is the current situation.
Realistically, players have little incentive to do anything else but pump and wait until the market prices send some companies into bankruptcy.