Saturday, October 11, 2014

SAR #14283

The Truth, with a capital T, is the sum of what the rich and powerful have decided works best for them. 
Brent, Bent: The price of oil has dropped significantly of late, flushing out the usual array of explanations, from lessening demand (a global recession is underway) to oversupply (fracking!). Let's look at some factors: Yes, there has been an increase in supply from the US oil shales. Yes, the economies of Europe and China (and the US?) are slowing. Yes, US drivers are driving less and driving higher mpg cars. And yes, to some small degree alternative energy sources have made a slight dent in the world's thirst for petroleum. 
While the US continues to keep Iranian oil off the market and has levied serious developmental sanctions on Russia, that has not dampened supply significantly. The conflict and disarray in Northern Iraq and Syria is keeping that oil off the market (except for about 80,000 bpd that the US continues to let the Turks let get to market). And hidden in all this static is the continuing depletion of the world's largest reservoirs. 
Importantly, the dollar has strengthened considerably, from $1.40 to the euro to $1.26 to the euro just this year – and oil is priced in dollars, so a 10% increase in the value of the dollar translates to about a $10 a barrel drop in the price of oil. This does not account for all the decline – Brent is down 20% in the last three months – but is part of the explanation.

Oil at the current +/- $90 a barrel (splitting WTI at $86 and Brent just over $90) is or is not a good thing depending on its cause (above) and its effects: It is certainly good at the US gas pump. But $90 a barrel would make about 9% of US shale production unprofitable and if that level held for very long could drive many American fracking/shale operators out of business with their highly leveraged operations and $80/barrel production costs. Oil at $80 would put about 40% of fracking producers out of business.

Ditto for the hoped-for expansion offshore of the Shetland Islands in the North Sea – and the British government is not prepared to take the budget hit that declining production tax revenues would yield. 
OPEC would seem immune because of their low production costs – with a Middle Eastern cost average of just over $16 a barrel. But most OPEC nations have budgets based on oil prices near or over $100: The UAE needs about $70 a barrel, the Saudi Arabia budget calls for $93, Iraq planned on $106 a barrel, Iran needs $130 a barrel (and isn't going to get it). How much swing does OPEC have? With about 30% of the world's traded production (ignoring domestic consumption), they have a strong influence but do not control prices unless they shut off their spigots which they cannot afford to do for long even though they have immense reserves of both cash and petroleum. The tensions within OPEC – the richer and better prepared vs the rest – will certainly add to the drama. Iraq is in the latter camp.

How will OPEC enforce quotas when budgets need sales?

How much longer can the shale industry survive? 
Does the price of oil still control the US economy?

Will the dollar's strength continue?

How far will China's economy fall?

Will Europe go into recession?

Place your bets.


Degringolade said...


I actually appreciate it greatly when you write yourself rather than repost and comment.

Not that I don't read your other stuff every day, it is just good to hear your voice in the fore, rather than merely adding postscripts to others.

As always, all the best.

John E.

bern said...

I also appreciate your insightful observations on our unfortunate decline.

Charles Kingsley Michaelson, III said...

A reader noted that I had left out both the Fed's tapering (or not) of QE and the role of speculators in the price drop.

While both undoubtedly have some effect, I think that the current drop is due to forces greater than either the fed or speculators - and may to some degree be a reaction to their machinations.

ckm (and thanks for the strokes!)

Demetrius said...

Uh, uh, way to go, all bets off.