Opec: Oil Prices Are Falling Fast and This is Why

Oil prices are falling sharply as global demand remains subdued, the US increases its production and Opec countries vow to uphold rather than cut their current levels of output.

Brent crude is nearing the $71 (£45, €57) per barrel mark, around a four year low. Since a 24 June peak of $107.48, Brent has plummeted by more than 30% in price per barrel.

And it looks like these price levels will remain. Igor Sechin, chief executive of Russian state oil giant Rosneft, said he expects Brent to be between $70-$75 on average in 2015. Some fund managers have said it could slide as low as $60.

The International Energy Agency (IEA) predicts global oil demand to drop in the first half of 2015. It is 93.55 million barrels a day in the last quarter of 2014, but will slide to 92.64 million barrels per day in the first three months of 2015.

A slump in demand is being driven by various economic concerns across the world. China's powerhouse growth is slowing, the Eurozone is flat-lining, and Japan and Brazil have both re-entered recession.

Moreover, a sanctions battle between the West and Russia over the latter's actions in Ukraine is weighing on the global economy, particularly in Europe. As output dips, so does demand for oil. Which has left a glut of supply in the market.

What's more, the shale boom in North America has led to a sudden increase in oil supply. Data from Standard & Poor's shows a 60% increase in the export of refined oil from the US since 2010 as the country exploits its vast shale resources. Output is expected to hit a 42-year high in 2015 at 9.4 million barrels a day.

Ordinarily, we would expect Opec – an organisation for oil producing countries – to agree a cut in production, which would limit the supply and push prices up.

But after a November meeting, they agreed not to reduce their production cap of 30 million barrels per day for the coming six months.

This irritated the poorer Opec countries, such as Iran and Nigeria, which struggle to balance the books with oil prices so low. Production can quickly become uneconomical. But others, like Saudi Arabia, want to keep the price low to put pressure on US shale oil producers.

"We are not sending any signals to anybody. We just try to have a fair price," insisted Opec Secretary-General Abdalla El-Badri.

Like the poorer Opec countries, US companies producing oil also have a point when the price makes things uneconomical. By holding down the oil price, Opec is applying pressure on US oil production. But it looks like we're some way off any problems for the US yet.

From a Bloomberg article:

Only about 4% of US shale oil production needs prices above $80 for drillers to break even, the International Energy Agency said today in its monthly oil market report. Producers are getting more oil per dollar spent drilling, driving costs down as much as $30 a barrel since 2012, Morgan Stanley (MS) analyst Adam Longson said in a report yesterday.

"Prices aren't low enough to put these projects at risk," Matthew Jurecky, head of oil and gas research for the London-based research company GlobalData Ltd., said by e-mail today from New York. "The profit margin on most commercial unconventional oil plays will support prices as low as $50, many below that even."

Others are saying this is a dramatic shift for the oil market. Opec can no longer dominate and manipulate the market to its whim. Michael Wittner, senior oil analyst at Societe Generale, said in a note:

Welcome to the new world of oil. Saudi Arabia and Opec will no longer be the mechanism to balance the market, they have relinquished that role.

Instead, the market itself - prices, in other words - will be the mechanism to rebalance the market. We cannot overstate what a dramatic and fundamental change this is for the oil market.

Here's what a report by HSBC oil and gas analysts had to say about the recent price falls:

The near-term impact of lower oil prices is likely to be varied. Clearly, oil producers will suffer and oil importers benefit.

However, we caution against getting too carried away with the good news that comes with lower oil prices.

At least in part, falling oil prices represent an ongoing deficiency in global demand which is manifesting itself in disinflationary pressures not just in commodity prices, but also wages. A further drop in inflation could spur central banks to become even more dovish.

Off the back of falling oil prices, oil firms' share prices have been hit. The Dow Jones Oil & Gas Titans 30 Index was down over 4% in early trading on 28 November. BP shares were down 1.6%, Royal Dutch Shell had dipped almost 2% and BHP Billiton had fallen 3%.