Will Oil Prices Rise Or Fall?
We examine the global oil market to try to determine if prices are set for a spike or poised for a plunge.
Published on 5 December 2017
Last month, 11 Saudi princes and a number of other high-ranking officials were arrested on the orders of Saudi Arabia’s de facto ruler, Mohammed bin Salman. The ostensible reason for these arrests was the country’s drive to clamp down on corruption.
Fearing political upheaval in the world’s largest oil exporter, the markets drove crude prices to their highest level in over two years. With global benchmark Brent Crude oil currently hovering around US$63 a barrel, a return to the sub-US$30 levels seen in January 2016 seems unlikely to happen anytime soon.
There are several other reasons for the recent spike in oil prices. Northern Iraq’s Kurdistan region is another important Middle East oil producer, but most of its production flows through a pipeline to the Turkish port of Ceyhan. Iraq’s Kurds are demanding that country of their own be established and recently held a referendum to vote on this issue.
This has angered Turkey and the Turkish president Recep Tayyip Erdogan has threatened to shut down the pipeline. “We have the valve. And the minute we shut it down, that’s done,” he declared. If this happens, world oil supply will be hit and prices could rise further.
The rise in oil prices has also been fuelled by an increase in oil consumption. The International Energy Agency (IEA), a Paris-based organisation established by the the Organisation for Economic Co-operation and Development (OECD) countries in 1974, recently said that oil demand will rise faster than expected this year. In the second quarter of 2017, global economic expansion resulted in demand rising by 2.3 million barrels per day. The IEA expects oil offtake to continue to rise in 2018.
In a bid to prevent oil prices from falling, the Organization of the Petroleum Exporting Countries (OPEC) and other big producers like Russia hammered out a deal to curb output about a year ago. The OPEC countries – which include Saudi Arabia, Iran, Iraq, and Kuwait – said that they would cut production by 1.8 million barrels a day starting in January 2017. Non-OPEC producers chipped in with an additional cut of 558,000 barrels per day.
The reduction in output has had its desired effect:
At the recently concluded 173rd OPEC meeting, member nations agreed to extend the production cuts until December 2018. Russia, a major non-OPEC exporter, has also agreed to continue with the limits that it has placed on its oil output.
However, the cooperation between OPEC and non-OPEC countries may be short-lived. While arriving at these agreements can be difficult enough, ensuring that each signatory adheres to the committed level of production can be even harder to enforce.
At times, a big producer may flood the market in a strategic move. Back in June 2014, oil was priced at US$115 per barrel. By December of that year, it had crashed to US$70 due to lower global demand and a steady stream of output from the world’s large producers.
Saudi Arabia refused to curtail production as it thought that lower prices would drive a number of US shale producers out of business. However, that didn’t happen. Improvements in technology allowed American shale companies to remain profitable even at lower prices.
Sheikh Zaki Yamani was Saudi Arabia’s oil minister from 1962 to 1986. In 2000, many years after he retired from that position, he famously said, “Thirty years from now there will be a huge amount of oil – and no buyers. … The Stone Age came to an end, not because we had a lack of stones, and the oil age will come to an end not because we have a lack of oil.”
The development of electric vehicles and the rapid growth that has been forecast for them makes Sheikh Yamani’s words seem prescient. In 2015, OPEC estimated that by 2040, the number of electric vehicles on the world’s roads would total 46 million. But a year later, they raised their estimate to 266 million vehicles.
How will the rise of electric vehicles affect the demand for oil? Barclays, an investment bank, estimates that by 2025, electric cars will decrease oil demand by 3.5 million barrels per day. By 2040, this reduction will rise to nine million barrels per day.
However, recent developments could see the demand for oil falling even faster. Tesla, the high profile maker of electric cars, has unveiled a prototype electric truck. If battery powered trucks catch on, it could revolutionise the transportation sector. This development would also result in oil demand dropping drastically. Currently, trucks and cars account for about 70% of oil consumption.
In 2008, oil prices touched US$140 per barrel. At that time, the common wisdom was that world oil production had flattened out. Industry experts held the view that the cost of production would rise as harder to access reserves would be more expensive to develop. Additionally, US production from its shale reserves had not picked up.
But it seems that the experts were wrong. The shale oil revolution has reduced US dependence on imports. The Permian and Eagle Ford basins produce about two-thirds of the country’s total shale oil output of 6 million barrels per day. The Permian basin alone produced 2.2 million barrels per day at the beginning of 2017. By the end of the year, the output is expected to reach 2.7 million barrels per day. By the end of 2018, production will reach 3.3 million barrels per day.
The position is comfortable at a global level too. Proven reserves of oil across the world are sufficient for many decades of consumption at current rates.
Current yearly consumption is about 35 billion barrels. Global reserves stand at over 1,400 billion barrels. That’s enough for almost 50 years.
The world’s producers may be able to hold off the decline in oil prices in the immediate future. But in the longer term, new technologies and the rising chorus of voices against global warming could result in a fall in both demand and the price of oil. In July this year, Credit Suisse, a Zurich-headquartered financial services company, released a report saying that oil prices would remain at sub-US$60 levels until 2020.