AS oil prices continue to dip further, the global oil price regime has shifted from a controlled price-setting environment to a more laissez-faire system influenced by supply and demand.
Last Tuesday, the benchmark Brent crude dropped further to US$82 per barrel, the lowest since October 2010. It has fallen close to 30% from its recent peak of US$115 in June. On Thursday, Brent closed at US$83 per barrel while the US light crude West Texas Intermediate (WTI) closed at US$78 per barrel.
Industry analysts say the situation is largely due to supply and demand imbalances that indicate the emergence of a new oil price regime.
Previously, the Organization of the Petroleum Exporting Countries (Opec), and especially the largest producer in the 12-member grouping, Saudi Arabia, had a major influence over oil prices. Opec is responsible for 40% of the gobal oil supply.
Market observers point out that the oil and gas (O&G) industry is now entering a “loosening” oil price regime in which the supply glut in the US has an increasing impact, with the country now playing a major role in the direction of oil prices.
An industry consultant tells The Edge that the current slide in oil prices is mainly due to continued strong supply growth from North America’s shale gas, lower demand in China and Europe as well as a delayed reaction from the price monitor, Opec.
“In the last four months, there has been abundant supply, especially in the Atlantic Basin due to strong growth in the US output and recovery in political wildcard producers such as Libya,” she says.
She adds that some quarters project 2% annual growth in crude oil supply for 2014.
The US’ total output has increased by about one million barrels per day (mbpd) between January and August. The increased production is a result of a combination of horizontal drilling and hydraulic fracturing, or better known as “fracking”, which has unlocked supplies from shale formations in the country.
Massive discoveries in North Dakota and Texas have sent oil prices lower, even amid tensions in the Middle East and the Ukraine that would have driven prices higher in the past.
However, the US is not the only country ramping up production. Iraq increased production by 200,000 bpd in May and Libya has also doubled its production from 230,000 bpd to 560,000 bpd between July and September.
But the increasing oil supply in the US is not the only factor. As oil supply rises, global demand has begun to decrease in tandem with slower growth in many countries.
Sluggish economies in Western Europe and a slowdown in China are some of the factors that have contributed to the drop in demand.
In its World Economic Outlook report released last month, the IMF cut its economic growth forecasts for 2014 and 2015 for the third time this year. Global gross domestic production growth forecasts have been reduced to 3.3% for 2014 and 3.8% for 2015, led by revisions for Europe, China, Brazil and Russia.
In light of this, the US Energy Information Administration (EIA)’s forecast of global oil demand for the fourth quarter in 2014 has also been reduced to 91 mbpd from 93.5 mbpd previously.
The EIA has also revised downward global petroleum product demand growth in 2014 from 1.4% to 1% due to reduced expectations of economic growth and the recent weak demand trend.
Nevertheless, the agency is positive that global demand will gradually increase. It expects the momentum to accelerate in 2015, both economically and in oil-demand terms, but at a reduced rate.
Has the US taken over Opec’s role in the oil price regime?
The volatility in oil prices is also influenced by OPEC’s delayed reaction as Middle-Eastern exporters aim to protect their market share in Asia against increasing competition.
As the oil exporters are displaced by North America shale gas, there has been rising competition among crude oil producers in the Asian markets.
The Atlantic Basin crude oil producers from West Africa and South America are targeting to channel their supply to the Asia-Pacific markets such as China, India and Japan.
Interestingly, instead of stabilising oil prices, Saudi Arabia unilaterally lowered its price for Asia. Saudi Arabia has now reversed its plan Last week, it decided to increase crude prices for Asia and cut oil prices in the US, focusing its fight for market share in the country.
It appears the US’ influence on the oil market is becoming stronger to the point that OPEC has to reduce prices as a means of maintaining its market share.
Already, several research houses are revising down their near-term oil price forecast, citing the combination of rising oil supply and shrinking demand and rising supply outside of OPEC.
Goldman Sachs Research estimates that Brent and WTI, the two most common classifications for oil used and sold, will fall to US$85 per barrel and US$75 per barrel respectively in the first three months of 2015.
“Our confidence in a 2015 oversupplied global oil market has increased,” says Goldman.
It attributes the decline in oil prices to increasing production growth outside of Opec that will outpace demand growth and leave the oil market oversupplied.
With the US now becoming a major oil producer, Goldman also points out that, “Opec will no longer act as the first-mover swing producer and that US shale oil output will be called upon to fill this role”.
This would remove Opec’s power to set global prices for crude oil. The shift in pricing power became apparent to Goldman when the US’ shale’s spare capacity of about 5 mbpd exceeded Saudi Arabia’s 1.5 mbpd. (Spare capacity refers to the amount of crude a country is able to produce in 30 days in case of an emergency.)
Daily oil production in the US has soared by about three million barrels since 2011 to 12.6 mbpd as at September, according to the EIA. It also reveals that current production is at the highest since 1986.
This month, market observers expect the US to pump the highest amount of crude oil, making it the world’s largest oil-producing country and knock Saudi Arabia off the podium.
All these factors point to lower crude prices in the next couple of years.
This article first appeared in The Edge Malaysia Weekly, on November 10 - 16, 2014.