When the oil price peaked at around $115 a barrel, nobody foresaw the plunge that would follow over the next seven months. Prices dipped to $46 at the beginning of this year – the lowest since 2009 and a painful reminder of the crash to $36 a barrel during the economic crash.
Producers and buyers alike were taken by surprise. However, Christof Rühl, global head of research at the Abu Dhabi Investment Authority, said it was only a matter of time before prices took a dive.
“These very stable three years of [high] oil prices did not reflect a stable situation at all. Why the prices lasted so long, so high and so stable was because we had the shale boom from the US, supply disruptions mostly from North Africa and the Middle East, civil war in Libya and sanctions against Iran.
“However, that was never a stable situation; that was living on the edge and it was just a matter of time for this system to fall.
“The gradual increase in production from the US, the return of production from Libya, and output from Russia, were enough to drive the system over the cliff and make prices fall. In that situation, had we had only the US shale growth we would have seen prices come down much earlier,” he added.
Oversupply of crude from OPEC producers and the US shale boom, coupled with slow global economic growth and weakened demand in Europe and Asia, have emerged as the top reasons why prices dipped by almost 60% over the last seven months.
To cut production seemed like a simple solution to the problem, which was exactly what the Organisation of Petroleum Exporting Countries (OPEC) was urged to do at their meeting in November. However, the group decided to keep output unchanged.
Ali Khedery, CEO of Dubai-based consultancy Dragoman Partners, explains that OPEC’s decision, although widely criticised and blamed for the slump in prices, was very strategic.
“For Saudi Arabia and the other Gulf Arab producers, the fundamental decision recently to maintain production is grounded in economics and trying to maintain market share.”
Speaking at the 6th Gulf Intelligence UAE Outlook Energy Forum, the UAE energy minister Suhail Al-Mazrouei said cutting production now would have meant repeating the same mistake OPEC made in 2008, when the group curbed output by 4.2mn barrels and suffered losses of revenue as a result.
“The glut today in the market is about 2mn so if we reduce [production], someone will take that advantage and we will have the same problem again,” he commented.
As analysts have said, one of OPEC’s main motive behind the decision to keep production unchanged is to drive shale producers out of the market. Due to high production costs, it is not economically viable and makes no financial sense for the US to continue to produce expensive shale at the current depressed prices. By comparison, Gulf producers like the UAE and Saudi Arabia have very low production costs and would still make a profit even at prices below $50 a barrel.
However, reports suggest that in some fields shale companies have lowered their cost so much that they can make profits even at the $50 mark. And because shale wells are short-lived, producers do not often make long-term plans, making it even harder to predict, control and adjust output accordingly. The best approach, Rühl says, is to wait for prices to stabilise.
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“OPEC faced a dilemma. Cutting [production] would have meant prices returning to $100 or so; that would have meant continued North American production growth, loss of market share and loss of revenues.
“Not cutting would have meant loss of revenues. In that situation the rational first step was to let prices adjust,” Rühl added.
The UAE’s minister also said the group was “better off leaving the market to stabilise” rather than make any rushed decisions.
“It is good for the consumers; it is good for the world economy. We need time and so do those giant economies like China, for example. No one from this region can dictate the price anymore and we are not interested in dictating that price anymore. We are not in the 70s or 80s; we have open economies now.”
However, experts warn, the $80 a barrel price might be the new norm, leaving the $100 mark behind in history. This will inevitably take its toll on GCC economies. Saudi Arabia, for instance, needs a price of at least $100 a barrel to balance its budget, while the break-even price for the UAE is $80.
Even if prices stabilise at the $65 mark, which has so far failed to happen, all six of the GCC nations would run a combined budget deficit of about 6% of gross domestic product, according to Arqaam Capital, a Dubai-based investment bank.
Kuwait, for example, which relies on 95% oil revenue for its income, is already feeling the pinch. Finance minister, Anas Al-Saleh, said last month that he is expecting a budget deficit to materialise over the next couple of years. Oman also admitted that the drop in prices has affected the income of some GCC countries.
The oil price slump has also driven some changes domestically as leaders have started taking measures to mitigate the impact on their budgets. In January, Kuwait, Oman and Abu Dhabi cut some of their energy subsidies, while Bahrain increased the price of natural gas. Fuel subsidies are common practice in many Gulf states for keeping domestic prices low, but it is govenrments that pick up the shortfall in revenues.
Qatar, on the other hand, which is said to be least affected by the oil price slump is reportedly making plans to base its 2015-2016 budget on $45 a barrel price. Saudi Arabia is also planning certain budget cuts which combined with its cash reserves would allow it to operate comfortably in a low price environment for many years to come.
However, that would be impossible for neighbouring Iran, Bahrain and Algeria which need prices of between $120-130 and do not have the same reserves, according to Khedery.
The one good news lately was that the Middle East will see exploration and production spending rise by 14.5%, according to research by Barclays Capital.
Barclays analyst, David Anderson, said: “Saudi Aramco and ADNOC are defiantly moving ahead with activity levels on projects largely unchanged as both are prepared to accept lower oil prices in the near term, with the expectation of improvement toward the end of the year.”
However, despite the prognosis of continued investment and therefore stable global supply, demand prospects, particularly from Europe and Asia, remain low.
“Economic recovery in Europe is going to be very slow, and that means very slow recovery in demand. There is a lot of uncertainty and we have to be realistic even when we have signs of growth, it is being fed by steroids and low interest rates,” said Lord David Howell, UK’s former secretary of state for energy,
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“There is a medium and longer term demand insecurity that technology is racing ahead. Technology is not going to increase demand, it is going to flatten [it] as it has done for many years in America and Europe. Energy intensity is reducing dramatically, while energy efficiency is increasing. It will not surprise me if demand insecurity, which is revenue insecurity is what happens. It is what investors hate but it is a probable thing,” he added.
Analysts predict that in about 20 years, demand for natural gas will have grown three times as fast as demand for oil. This will radically change the global energy mix, leaving oil, gas and coal with a share of 25-30% each. Emphasis has also been put on renewable as an alternative source of energy.
The overall sentiment of the future of oil price may appear to be dominated by many unknowns, but supply and demand will remain the most important factors.
“There is an uncertainty in the outlook because the underlining potential for disruption [of production] or diminishing disruptions and increase in production and that makes the situation more unpredictable”, Rühl said.
