Lower Oil Prices 2015

Lower Oil Prices 2015

Updated January 6, 2015
Lower Oil Prices 2015
Oil prices, long recognized as volatile, have declined
During its history, opinions on the degree to which OPEC
sharply since June 2014. During the last week of June 2014,
can control the price of oil has varied. The method OPEC
the prices of Brent, the world reference crude oil, and West
can use to control price is to raise oil output if the price is
Texas Intermediate (WTI), the U.S. reference crude oil,
increasing too much, or to cut oil output if the price is
were $113.74 and $107.04 per barrel, respectively, at their
falling too much. If OPEC pursues these adjustment
peaks. As 2015 began, the price of Brent was $57.86 and
strategies, their market share, or sales volumes, increase
the price of WTI was $53.46. These prices represent almost
during rising prices and fall during periods of declining
a 50% reduction. It is uncertain how far prices will decline,
prices. In the current environment, it might have been
or how long the period of lower prices will persist.
expected that OPEC would act to support prices.
Since oil is a major traded commodity, used by consumers
OPEC met on November 27, 2014, and chose not to take
and industry the world over, the effects of these sharp cuts
any action to prevent further cuts in the price of oil. Their
in price are likely to be felt in virtually every nation in the
decision was to keep their oil output steady, even in the face
world. However, whether the effects are positive, negative,
of declining oil demand. This action signaled to the market
or mixed depends on the economic characteristics of the
that they were willing to see their overall oil revenues fall.
particular country. In general, consuming nations, net
Of course, not all OPEC members agreed with this strategy.
importers of crude oil, might be expected to benefit, while
While Saudi Arabia, Kuwait, and the United Arab Emirates
producing nations, net exporters, might be expected to
supported the strategy, nations that depend heavily on oil
suffer; many nations will experience mixed effects.
revenues to support their national budgets, like Iran,
Venezuela, and Nigeria objected. Since the OPEC meeting,
Why Lower Prices? Three key factors have contributed to
informal comments by Saudi officials suggest that the
the low oil price environment: demand growth, supply
steady output levels are likely to remain in effect for a
growth, and the actions of the Organization of the
while.
Petroleum Exporting Countries (OPEC).
OPEC faced a dilemma at the November meeting. If they
Oil demand growth largely depends on the growth rate of
successfully supported the price of oil by cutting output,
the world economy. In 2014, growth in Europe approached
high prices would have provided a continuing incentive for
recession levels, Japan was largely stagnant, and even
U.S. shale oil producers and other non-OPEC producers to
China saw growth rates fall to roughly one half of what
continue to expand output. If output continued to expand,
they were during earlier periods. In the United States,
additional OPEC output cuts would likely have been
economic growth was modest in the first half of 2014,
required in the near term to keep prices high. Since most of
picking up only in the last quarter of the year. The net effect
the burden of reduced output falls on Saudi Arabia, their
of this economic growth picture was that oil demand
financial position might have been compromised, while the
growth was very weak. Major international agencies
other OPEC nations were shielded from the worst effects.
tracking the oil market, including the International Energy
Agency, the Energy Information Administration, and even
If OPEC decided, as they did, to hold oil output steady and
OPEC, revised forecasts of oil demand growth downward
let prices fall, all the member nations would share the pain
during 2014.
of reduced oil revenues. Some OPEC nations might even be
encouraged to try to expand their output to preserve
On the supply side, output expansion was the key factor.
revenues. However, if, as OPEC believed, U.S. shale oil
U.S. supply of light, sweet, shale oil from the Bakken
production and Canadian oil sands production is possible
formation in North Dakota, and the Eagle Ford formation in
only in a high oil price environment, then low oil prices
Texas transformed the market. U.S. crude oil production
might reduce the growth rate, or perhaps even the level, of
has risen from about 5 million barrels per day (mb/d) in
these non-OPEC supplies and create market conditions
2008 to almost 9 mb/d in December 2014. This increased
conducive to a higher price of oil in the long term.
production has reduced U.S. imports of crude oil, causing
exporting nations to look for other markets. At the same
Who Gains, Who Loses? Because of oil’s importance in
time, weak global demand was reducing selling
the world economy all major consuming and producing
opportunities.
nations will experience a mixture of positive and negative
effects. For the United States, the benefits of lower prices
While both the demand and supply sides of the global oil
are likely to be wide-spread, while the costs are likely to
market seemed to be signaling lower prices, one other
center on the oil industry and industries and regions that
critical factor was important, the decisions of OPEC.
depend on the oil industry.
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Lower Oil Prices 2015
Since the price of oil directly determines the price of
Venezuela is being squeezed out of capital markets, and
gasoline, diesel fuel, jet fuel, home heating oil, and a
may become ungovernable. A quasi-state damaged by low
variety of other petroleum products, individual consumers
oil prices is ISIS. ISIS has been financing military activities
and industries that use these products will benefit. Gasoline
in Syria and Iraq through the sale of limited amounts of
prices have declined by over 68 cents per gallon from
captured oil. Any given quantity of oil will yield them less
December 2013 to December 2014. It has been reported
revenue in the new market environment.
that these cuts in the price of gasoline translate into about
$630 million per day in savings for consumers. Consumers
Issues for Consideration. Two issues that have been
can use those savings to purchase other goods and services.
discussed during 2014 may be affected by low oil prices.
Similarly, the airline and long-distance trucking industries
As U.S. production of shale oil has increased, there has
are reaping substantial cost savings that encourage
been some difficulty in absorbing it into domestic markets.
economic growth.
U.S. refiners invested heavily in modifying their facilities to
accommodate expected supplies of heavy, sour, oil. This
Even though U.S. oil production has increased, the nation is
forecast was actually the opposite of what occurred in the
still a net importer. As a result, the fall in oil prices will
market, a surge in light, sweet, oil. As a result of the
help reduce the nation’s balance of trade deficit, likely
refinery mismatch, Bakken and, to a lesser extent, Eagle
resulting in a stronger value of the dollar.
Ford shale oil has sold at a price discount compared to
WTI. Producers, hopeful of enhancing their revenues,
Other consuming nations, including those in Europe and
began to petition for lifting the ban on U.S. oil exports
Asia will also experience consumer benefits. However, the
which has been in place since 1975.
lower price of petroleum products coupled with stronger
economic growth may increase the demand for these
If all oil prices decline proportionally, pressure to allow the
products.
general export of U.S. crude, now possible only to Canada
and through several other minor exceptions, will continue.
The low price of oil is difficult for firms in the oil industry,
If the low oil prices reduce the Bakken price discount, the
weakening their financial position and inducing them to
debate on oil exports will likely be affected.
curtail investment plans. The key asset held by oil industry
firms are their oil reserves. As those reserves decline in
The second issue affected by low oil prices may be the
value, the balance sheet of the firm weakens and their share
federal gasoline tax. The gasoline tax, used for highway
prices tend to decline. In addition, the lower price of oil
maintenance and construction, has not been changed since
also reduces cash flow, and potentially profitability, further
1993. Since that time, maintenance and construction costs
weakening the share price. The overall effect of low oil
have risen. The Highway Trust Fund has become
prices on the stock market is uncertain however, because
chronically short of funds. With the rate fixed at 18.3 cents
while share prices of oil industry firms are declining, the
per gallon, revenue only increases as more gallons are used.
prices of oil consuming firms, like airlines, are rising.
Recently, however, due to increased fuel efficiency and
Virtually all oil sector firms are hurt by low prices, but
fewer miles travelled, gasoline usage has declined or is
perhaps those small firms involved in shale production,
stable, reducing revenue potential. Conversely, low
depending on cash flow and debt financing, suffer the most. gasoline prices may motivate higher consumption, and
hence, revenues.
If the firms largely responsible for the increase in shale oil
production falter, and either reduce exploration and
Due to taxpayer resistance, it is difficult to increase
development investments, or actually reduce output, U.S.
gasoline taxes when prices are high and rising. It may be
production growth might slow and provide a market
possible to increase the tax in an environment of low and
correction for low oil prices. Of course, a reduction in oil
declining prices. Consumers may be more willing to
extraction rates in 2014 leaves more oil in the ground for
sacrifice a portion of a price decline in the interests of
the future, perhaps extending the time horizon for shale oil.
improved highway maintenance and construction.
State and local revenues from oil-related taxes, royalties,
The Future. While the near-term market conditions suggest
and lease payments may decline with the price of oil.
continuing low oil prices, a sharp cut in output by Saudi
Arabia could change the market quickly, albeit at
Some nations are likely to experience largely negative
substantial cost to the Saudis. In the longer term, the
effects due to lower oil prices. For example, Iran, Russia,
inability to predict oil prices almost guarantees that analysts
and Venezuela, nations that depend on oil to drive their
will be surprised by the evolution of the market.
economies, are in trouble. On December 16, 2014, Russia
was forced to raise domestic interest rates from 10.5% to

17% to attempt to protect the value of the ruble which had
been declining along with the price of oil. Iran, faced with
Robert Pirog, Specialist in Energy Economics
low oil prices in addition to economic sanctions, is finding
it difficult to finance the government. It was reported that
IF10026

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Lower Oil Prices 2015

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