Why oil price may fall more but unlikely to stay low for long

PUBLISHED : Thursday, 14 January, 2016, 2:24pm
UPDATED : Thursday, 14 January, 2016, 2:24pm

International crude oil prices could drop further but will unlikely stay below US$30 for long as many oil and gas projects are making losses, resulting in production cutbacks that will ease oversupply.

“Despite the oil market’s latest pullback, we continue to expect that the global oil market will regain an improved balance during this year’s second half, which should fuel a price recovery,” analysts at Canadian brokerage RBC Capital Markets said in a note. “The latest oil price convulsion will place even greater pressure on producers to hunker down from a capital spending standpoint, which should serve to rein in [production].”

According to commodities sector consultancy Wood Mackenzie, in last year’s first half alone, some 22 major oil and gas projects – involving seven billion barrels of oil equivalent (boe) of proven extractable reserves – have been deferred due to low oil prices.

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This is in addition to 46 projects with 20 billion boe that have been put on hold previously. Together, the 68 delayed projects means US$380 billion of total project expenditure has been stalled and put under review. Of that, US$170 billion were budgeted to be spent between this year and 2020.

The Brent benchmark crude oil price dropped 2 per cent in US trading on Monday and briefly fell below US$30 a barrel for the first time since 2004.

Analysts believe a significant rebound is unlikely in the short term and more downside is possible, given Iran – the world’s seventh largest producer in 2014 – is expected to ramp up production after the likely lifting of economic sanctions by the United Nations early this year.

“While we still believe there could be a recovery in oil prices in this year’s second half as markets rebalance, much will depend on data points over the next few months,” wrote American brokerage Sanford Bernstein senior analyst Neil Beveridge in a report. “With Iran set to increase exports over the coming months as sanctions are lifted, there is certainly no reason to believe that crude can bounce back in the short term.”

In particular, he said, China’s oil consumption and import growth figures will be closely watched as it is the world’s largest oil importer whose import volume surged 8.8 per cent as it took advantage of low prices to fill its strategic oil reserve facilities.

China’s crude oil demand was estimated by RBC to have grown around 5.8 per cent last year.

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Beveridge pointed out that nations in the world’s largest oil cartel will see their already stretched public finances strained further and will be under pressure to cut back on production after shale oil production in the US – the biggest global oil output growth driver in recent years – falls further.

“At current oil prices, no OPEC (Organisation of the Petroleum Exporting Countries) country in the Middle East will come close to balancing their budget this year,” he said, adding the oil cartel’s member nations require oil to fetch US$52 to US$98 a barrel to balance their government budgets.

In particular, Saudi Arabia, the world’s second largest oil producer after the United States, needs an average oil price of US$98 to break even on its budget this year.

If oil price averages US$37 a barrel this year, the kingdom’s budget deficit is estimated to reach US$149 billion, or 23 per cent of its gross domestic product, rising to 26 per cent if oil averages US$30 this year, Beveridge said.

At current oil prices in the futures market, the kingdom will fall into a net debt position by 2018 and will be forced to either slash its government spending, devalue its currency or sell state assets.

Among the 68 projects delayed due to low oil price, those that are newly developed oil and gas fields require oil price to be at least US$68 a barrel to break even, according to Wood Mackenzie.

Over half of them are deep water projects, as companies have been forced to rework their project plans to lower costs so that they will have a greater chance of being profitable.

“Tumbling prices and reduced budgets have forced companies to review and delay final investment decisions on planned projects, to reconsider the most cost-effective patch to commerciality and free up capital just to survive at low prices,” said the consultancy’s principal analyst Angus Rodger.