Rise in global production keeps oil prices subdued

In 2013, crude oil catered to approximately 33 per cent of global energy needs, the highest among all the energy sources. This clearly states that crude oil is a lifeline of any economy.

However, during the past couple of years, the dependence on the commodity has been decreasing as indicated by a declining consumption growth and a slowing global economy.

A combination of rising production and faltering consumption has been the story for the commodity.

Let us assess the current factors driving the price trajectory of the commodity and the way forward. In the past two months (July-August), WTI and Brent crude oil prices have lost their value by around 17.5 and 15 per cent respectively. MCX crude oil prices have also declined by around 14.5 per cent in the same time frame.

Falling oil prices is due to combination of the factors i.e., rising production of shale gas in the US, OPEC’s dominance to keep the oil market well-supplied, and increasing production from Iraq, Iran, and Russia.

Continued growth in global production of petroleum and other liquids has outpaced consumption growth since August 2014, resulting in rising global inventories.

Global production (petroleum and other liquids) are increasing by an estimated 2.9 million barrels per day through July 2015.

Besides, the total global liquid inventories, according to Energy Information Administration (EIA), are estimated to have grown by 2.3 million barrels per day through the first seven months of 2015 – the highest level of inventory builds through July of any year since 1998.

Due to the inventory build-ups, crude oil prices have seen significant downward pressure in the near term.

In the OPEC nation, Saudi is the highest oil producer and oil makes up around 90 per cent of the government revenues. The rout in the oil prices has led the kingdom with its own set of problems as the price of Brent crude is roughly around $50 a barrel, less than half of what it was in June last year.

Despite the price fall, the kingdom continued to pump record amount of oil in the hope of putting producers with higher costs out of business.

However, with low oil prices, revenue short falls and excessive spending, the budget deficit is estimated to be 20 per cent of GDP, according to the IMF (International Monetary Fund).

The aim of the Saudi’s is to defend its market share and hurt any number of rivals including Russia, Iran, or the US shale oil industry.

At present, US is producing around 8.8 million bpd while Saudi Arabia is producing around 9.6 mbpd and Russia is producing at a rate of more than 10 million barrels per day – a record high since the breakup of the Soviet Union, and is expected to keep output at that level in 2016.

If reports are to be believed, the cost at which shale producers can’t even break even is $50 and sustained price levels below the threshold mark will put shale oil producers bankrupt. That leaves many shale producers in the United States with little or no profit margin. The low price of crude in turn has led shale producers to cut the rigs in operation by around two-third, from 1,600 to 650 rigs at present. While many believe that the deal Iran stuck with six world powers over its nuclear programme may even depress oil prices further.

According to Iran’s deputy oil minister, Mansour Moazami, Iran’s crude exports would nearly double eventually from 1.2 mbpd to 2.3 million barrels once the sanctions are lifted.

On the contrary, Russia’s energy minister says the cost of producing shale oil is likely to have bigger impact on the world oil markets. Oil prices have been low for constantly low for a fair period of time.

However, if the oil prices rise, the US shale drilling would increase as shale drilling has become more efficient and less expensive, thanks to improvement in technology as many drillers are able to constantly increase their output even at current low prices.

From an Indian perspective, the benefit of lower prices, coupled with ease of sanctions on Iran will allow India to import more crude from nation. This will, in turn, benefit the economy by less outflows of foreign currency in turn lowering the current account deficit for the nation. Whatever production increases from any corner of the globe, it is believed that the cost of shale oil production will have significant impact on oil prices in the months to come.

Hence, we expect oil prices to remain subdued from a two month perspective and WTI oil (CMP: $45.46) prices can possibly head lower towards $40 a barrel while MCX crude oil (CMP: ₹3,059) prices will go lower towards ₹2,600 a barrel.

The writer is Associate Director – Commodities & Currencies, Angel Commodities Broking Pvt. Ltd. Views are personal.