Sunday, November 30, 2014

As Oil Prices Fall, What Happens Next?

  • Last week, the Organization of the Petroleum Exporting Countries (OPEC)announced that, while global oil supply may be exceeding demand, it would not cut production.
  • The news triggered a significant decline in the price of oil, dropping over 12% last week and down over 30% for 2014. The news also negatively affected the stocks and bonds of a broad set of global energy players.
  • Leonid Fedun, vice president and board member at OAO Lukoil in Russiasaid, “The [U.S] shale boom is on a par with the dot-com boom. The strong players will remain, the weak ones will vanish” and “in 2016, when OPEC completes this objective of cleaning up the American marginal market, the oil price will start growing again,”
  • Note: OPEC (whose members include IraqKuwaitIranSaudi Arabia,United Arab Emerites and Venezuela) accounts for about 40% of global oil production.
  • The price of oil is driven by a complex mix of geopolitical and economic dynamics.
  • It is likely that OPEC (led by Saudi Arabia) has several objectives for driving oil prices down including 1) the desire to cripple U.S. shale/ fracking production efforts, 2) punishing Russia, whose economy is very sensitive to the price of oil for its invasive efforts in Ukraine, and 3) destabilizing ISIS, which finances much of its operations from the sale of oil.
  • Lower oil prices will likely have a negative impact on U.S. oil-producing states such as Texas and North Dakota, and other oil dependent economies such as ColombiaVenezuela and Norway.
  • However, declining oil prices can lead to lower gasoline prices and provide an economic boost to many consumers and lower input costs for products that include oil based components
  • Bottom line – a prolonged period of depressed oil prices may increase stress on energy sector business models (including alternative energy) and lead to industry restructuringUnexpected collateral damage may also occur

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