When the oil price bottomed at around $45 a barrel in January, some analysts expected the price to rebound to more than $100 before long. But the way things are going, “oil in triple digits will be a distant memory”, says Stephen Jones of Kames Capital. The price of Brent crude has slipped to a six-month low below $50 a barrel, and is down by 25% this year.
Futures prices have slid along with the spot price, suggesting that “the global oil market is going to take longer to rebalance than previously thought”, says Mike Wittner of Société Générale. For instance, a year ago futures were pointing to an average Brent price of $101 in 2016-2018. Now, this figure has fallen to under $60. That in turn implies that the global oil industry would forego $4.4trn in revenues in those three years, says Liam Denning in The Wall Street Journal.
Why the oil price has slid
“There’s not a lot of upside for oil,” says Jonathan Barratt of Ayers Alliance Securities. The glut in the global market, estimated at around two million barrels per day, shows no sign of shrinking.
In fact, it looks set to grow. Global demand growth is lacklustre amid China’s apparently intensifying slowdown and a downturn in many major emerging markets. The industrialised countries’ recovery remains weak by past standards.
Meanwhile, European and US inventories are at record highs. Oil cartel Opec has been pumping furiously, and now Iran has reached a deal on nuclear power development with the West, it could add 500,000-700,000 barrels per day to the global market as of next year, says Morgan Stanley. Most significantly, US production has proved unexpectedly resilient to last year’s price plunge.
After a sharp drop in recent months, the number of rigs looking for oil in America has risen again. Many explorers have managed to cut costs, while shale drillers have boosted their productivity. John Hess, boss of the Hess Corporation, says the firm has cut “drilling costs by 50%, and we can see another 30% ahead”.
IHS, a consultancy, thinks shale groups could shave costs by 45% this year, notes Ambrose Evans-Pritchard in The Daily Telegraph. Advanced drilling techniques allow firms to launch multiple wells from the same site, while computerised drill bits can ferret out cracks in rock. The upshot is that shale fracking isn’t actually as expensive as everyone thinks it is.
Bad news for Saudi Arabia
In particular, it isn’t as expensive as Saudi Arabia thinks, and its miscalculation could cost it dear, says Evans-Pritchard. The Saudis’ plan has been to guard their market share by allowing production to soar, lowering global prices and putting US shale operators out of business. But now it turns out shale firms are hanging in there because shale isn’t that pricey; and even though plenty will go bust, the technology and infrastructure is now established, so bigger companies will scoop them up and just keep producing.
So it seems Opec faces a “permanent headwind. Each rise in price will be capped” by an increase in US output. That could begin to threaten the Saudi economy. It needs a price of around $105 a barrel to balance its budget. This year’s budget deficit could reach 20% of GDP. It has reserves of $672bn to throw at the problem, but these are dwindling at a rate of around $12bn a day. Public debt is just 7% of GDP, but could climb rapidly once the reserves are gone.
Saudi already plans a $27bn bond issue to top itself up, the first debt sale since 2007. In a few years, the lavish social spending that has kept the regime stable could be a thing of the past – and an unstable region would become even more dangerous.