Analysis: Don’t be misled by recent lower prices in oil market

Analysis: Don’t be misled by recent lower prices in oil market

Carmine Difiglio*
Analysis: Don’t be misled by recent lower prices in oil market

In January of this year, the world oil market was in rough balance. The annual growth of world oil demand was essentially equal to the growth of world oil supply. Today, world oil supply exceeds demand by about one million barrels per day (about 1 percent of the world oil market). The accumulated imbalance during 2018 has grown world oil stocks and has now led to a sharp decline in prices. That’s good news for the industrialized world and, in particular, for Turkey, since it gets a double hit from high oil prices.

Turkey is highly dependent on imported oil. In addition, high oil prices also increase Turkey’s natural gas costs since, with some time lag, most international gas contracts link the price of gas to the price of oil.

If we examine the profile of oil prices over the last four years, we see something that resembles a rollercoaster at an amusement park. In the summer of 2014, Brent oil prices traded at about $110/barrel. Within six months, they crashed to $50/barrel. After a brief rally, one year
later, they dropped again to $30/barrel. As recently as two months ago, they climbed to over $85/barrel and, at the time of writing this article, are now below $60/barrel.

Oil analysts try to divine the oil market by looking at three things: Demand growth (largely dependent on the world economy), the supply of oil from countries outside the Organization of Petroleum Exporting Countries (OPEC), and how well the OPEC countries (now in cooperation with Russia) manage to keep the world oil market in balance. OPEC has had a difficult time doing this. When oil
prices were low, OPEC’s supply reductions were largely offset by increased production from U.S. “frackers.” They are a relatively new phenomenon. Until the development of U.S. “shale oil,” investments took five to 10 years to yield production. “Frackers” achieve production within six months of investment. For now, high oil production in the United States and OPEC is driving prices down. But this is not likely to be a permanent situation.

As I mentioned, conventional oil investments take five to 10 years to pay off. We will now be entering the five to 10 year time window since the oil price collapse of 2014. In 2015, major oil companies reduced their exploration and production investments by 25 percent. In 2016, they reduced them by another 25 percent and have not significantly grown investments since then. At the same time, production from the world’s giant oil fields is declining. The International Energy Agency’s (IEA) just-released 2018 World Energy Outlook predicts that U.S. oil producers won’t be able to offset the production decline from conventional fields. In a few years, the world oil market will become a lot tighter than during the last 10 years.

What are the lessons? First, we should not be complacent about the current lower oil prices. National efforts to reduce oil consumption should not falter. In addition, maintaining adequate strategic oil stocks remains as important as it ever was. This is the IEA’s responsibility as its member countries are obligated, by treaty, to maintain emergency oil stocks and to release them in concert with each other should that prove necessary. Under the leadership of its executive director, Dr. Fatih Birol, the IEA is also reaching out to encourage non-member countries to hold more strategic reserves and to coordinate their stock release with the IEA should there be another oil supply emergency.

peaking of Dr. Birol, he will present the 2018 World Energy Outlook on the morning of Dec. 20 at the Conrad Bosphorus Hotel. This event is organized by Sabancı University which invites anyone that is interested in attending.

* Prof. Difiglio is director of the Sabancı University Istanbul International Center for Energy and Climate.

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