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Despite the rebound – at the time of writing, Brent crude was trading at $37.58 a barrel – it is still a far cry from 2008’s peak of $145 a barrel, or 2014’s high of $112.04.
The slump, largely driven by a supply glut, has had a significant impact on business, consumers and economies around the world. Globally, more than 250 000 jobs have been cut in the oil and gas industry due to the slump, and companies have cut spending by more than $100bn, according to a 2015 report by industry consultant Graves & Co. Tens of thousands of jobs remain at risk, experts say.
The slump has also hurt oil-exporting countries. Nigeria, for example, asked for $3.5bn in emergency loans from the World Bank and the African Development Bank in January in an attempt to plug a $15bn budget deficit left by the drop in oil prices. The International Monetary Fund (IMF) has estimated that the drop in the oil price lowered state revenues of Arab oil-exporting states to the tune of $340bn in 2015, with further declines expected.
Yet low oil prices are traditionally a boon for the global economy, with the pain for oil exporters offset by the economic benefits of lower inflation in importing nations. Low oil prices traditionally also benefit equity markets, as lower fuel prices mean consumers have more cash to spend, while companies’ input costs are lower, thereby boosting profits. Over the past six months, however, equity markets have often moved in tandem with oil, with global markets declining in line with a drop in oil prices.
Oil and the economy
Ben Bernanke, economist at the Brookings Institution and a former chairman of the US Federal Reserve, said in a recent blog post investigating the link between stocks and oil prices that this positive correlation between oil prices and equity markets may arise “because both are responding to underlying shifts in global demand”.
According to one of his calculations, between 40% and 45% of the decline in oil prices since June 2014 can be attributed to unexpectedly weak demand. Other factors at play can be explained by overall uncertainty and risk aversion in the global economy, Bernanke said.
Maurice Obstfeld, chief economist at the IMF, and two colleagues wrote in a recent blog post that, while oil prices have been persistently low for more than 18 months, the widely anticipated “shot in the arm” for the global economy has yet to materialise. The IMF is expected to downgrade its growth outlook for the global economy, currently estimated at 3.4% for 2016, when it releases its World Economic Outlook this month.
Obstfeld and his colleagues argue that the world may be needing higher oil prices, and the resultant higher inflation, to spur growth. Low and even negative interest rates in many advanced economies have eroded the benefits typically brought by low oil prices.
Further adding to the concerns over demand, the International Energy Agency (IEA) said in its March report on the global oil market that there has been a “sharp deceleration in demand growth, particularly in the US (the world’s largest consumer of oil) and China”.
There is also concern over the impact of the oil price slump on the global financial system. Moody’s warned in February that the price slump will intensify pressure on banks globally, with those in major net oil-exporting countries most exposed to credit risks in the near term. According to statistics from the Bank for International Settlements, the global oil and gas industry’s debts have increased from $1.1tr in 2006 to $3tr in 2014, or more than eight times the size of the South African economy.
Has the oil price bottomed?
Economic forecasting firm Oxford Economics said in a March report that it expects the market to remain over-supplied for the foreseeable future, unless there are significant changes to supply “of the order of several million barrels per day”. Without significant cutbacks in Opec (Organization of the Petroleum Exporting Countries) production, there will be a limit on how far oil prices can rally, it said.
A major factor in the current supply glut has been Opec’s decision in November 2014 to stop managing output in order to balance the oil market, opting instead to try and maintain global market share (see sidebar) and force higher-cost producers out of the market.
This, along with the return of Iran to the export market, following the lifting of sanctions in January, has contributed to the significant oversupply in the market, which in turn has led to the major decline in prices.
The shale oil revolution in the US over the past decade has been seen as a game-changer for the industry, with US oil production almost doubling from 7.5m barrels a day in 2010 to a peak of 13.2m barrels a day in April 2015, according to data from Oxford Economics.
Due to technological advances, it has become commercially viable to extract more oil trapped in shale, a specific rock formation, through the process of hydraulic fracturing (fracking) and horizontal drilling. The increase in US output has led to Congress voting in favour of lifting the 40-year ban on US oil exports last year.
The oversupply is estimated at around 1.5m to 2m barrels a day, or 2% of global production, according to various estimates.
In its monthly oil market report released in March, the IEA said while the recovery in prices since mid-January shouldn’t be seen as a “definitive sign that the worst is necessarily over”, there are signs that prices may have bottomed out.
This is an excerpt of an article that originally appeared in the 14 April 2016 edition of finweek. Buy and download the magazine here.
