Oil and the Passing of Twilight

Just over two months ago, this site published an analysis of power politics in the oil markets (http://wp.me/p3g0mz-8I), suggesting that the Saudi Arabian government, just prior to losing the King Abdullah of a decade, had revealed their tactic of holding out for market share in the global supply markets. They were doing this by leveraging their influence in the cartel group OPEC, which controls the production levels of around a dozen oil exporters worldwide. Ten weeks on, the free-fall in the price of crude oil has ended, with WTI and Brent trades rising 20% or so from under $50 at the end of January to touch over $60 this week. Despite the feared floor having been avoided, analysts are now asking whether the damage has already been done to an industry and market that has relied on high prices and demand for so long. This article aims to outline some of the fallout from the narrative, as well as looking to the future on prices per barrel and the flux in consumer prices and inflation. Power politics may still be there or there abouts.

Source: Financial Times, 19/02/15
Source: Financial Times, 19/02/15

First and foremost, the last few days have told analysts that although prices have refrained from falling further, stability in prices is far from near. As mentioned, prices rose sharply at the start of last week and have been jumping and flagging practically every day since. This, it seems, makes life very interesting, and potentially profitable, for traders, such as Vitol, and vertically integrated producers, such as the supermajors like Shell and BP, who can buy stocks while prices are low, benefit from daily fluctuations in the short term, and sell on the future market to benefit in the long term. This dynamic is know as ‘contango’, and generally only comes about in periods of disparity between physicals and futures oil prices. This is fundamentally why, despite the huge price fluctuations, derivatives such as petrol prices have not followed suit and halved with crude prices. Supply side actors are trading so heavily in the futures markets that the physical sale of oil cannot have an impact on retail consumer prices. Whether or not, if crude prices hover around $60 a barrel, for instance, the current low price will have an impact six or eight months down the line, if not known for sure. But consumers will certainly be keen that this is the case. Despite supermajors generally getting away with falling crude prices – share prices in Shell and BP have fallen by just 7% and 8% respectively over the last 12 months – oil companies may find the next year very difficult. What has maintained profitability and dividends so far has been cuts to capital spending on new extraction and exploration projects: Shell in Canada, BP in the North Sea, Eni more generally, and all by a matter of billions – cuts that, by their very nature, are unsustainable. Cost cutting to save profit margins can only work in the short term, and oil firms have only followed this route to keep investors happy as the financial year draws to a close. How firms handle this in the longer term is going to be interesting to observe. The oil industry, again by nature, is incredibly cost-heavy, and so it will be difficult to keep this policy up. Either the industry as a whole needs to find some very cost-effective method of extracting oil out of the ground and distributing it around the world, or firms must look to gas, coal and renewables to replace the revenue lost to falling oil prices. This is where national economies come into the framework. As mentioned in December’s piece, generally, declining crude prices was most harmful to those economics that rely on revenues from oil exports – Saudi Arabia and the Gulf States, Nigeria, Venezuela, Russia, even Norway, to name a few. The Saudis are the least concerned, and have attempted to push competing producers out of the market by forcing OPEC to hold its nerve on production levels; the logic being that the Saudis have huge reserves of oil and can survive on low revenues, whereas, especially, American shale competitors need a higher price to break even. This is carnal political economy at its most intense. Elsewhere, however, things haven’t been so assured. The Nigerians have announced budget cuts, and are eying more, as initial estimates on revenue equilibrium based on oil at $65 a barrel look increasingly risky. Nigeria has in the past avoided budget holes by backstabbing revenues from oil exports, primarily the actions of Finance Minister Ngozi Okonjo-Iweala, but is looking to reduce exposure to crude price fluctuations through decreased dependency on oil in general. Elsewhere, Russia and Venezuela have pushed up central bank interest rates and devalued currencies respectively in bids not to let oil revenue depreciation interfere with other equally turbulent political maters, such as unemployment and international sanctions. This is the fascinating dynamic of the global oil markets – the dichotomy between, generally, producers and consumers of oil (perhaps more correctly the exporters and importers), and the political tension surrounding many producing economies precisely because of rentier-state economics, makes the market incredibly sensitive, and leads to impact on markets beyond commodities, including equities, bonds and foreign exchange. If one were to wake a friend from a six-month coma, it would be lovely to be able to tell them that there had been an effective global tax cut deriving from the drop in oil prices. This, however, has yet to materialise. Heavy importers, including much of Europe, have been seen slight lenience, but nothing on what might have been expressed. For all his efforts and successes in launching oil into the world markets at the end of the nineteenth century, J.D. Rockefeller must be turning in his grave at how little the individual matters to oil right now.


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