Zimbabwe: Balance of power reduces crude oil price

Oil-world 109 November 2014 – Brent crude, the international benchmark for oil, now trading in the US$80 per barrel zone, its lowest levels since October 2010, is now in a bear market territory.

The price has fallen over 35% since June 2014 on weak economic data from Europe and China, oversupply and a stronger US dollar.

Oil prices were under further pressure last week after it emerged that Saudi Arabia, the world’s largest exporter, had slashed its delivery contract price for its US customers in a further sign of a war for control of global energy markets.

The Saudi Arabia’s oil price drop could be targeted towards US shale producers in a bid to regain and preserve its oil market leadership by making US shale gas unprofitable. Saudi Arabia can sustain at prices as low as US$30 per barrel.

However, the current fall in oil price is far less steep than the plunge that was experienced in 2008, when the price fell from as high as US$145 per barrel in July 2008 to US$38 by December of the same year on the back of global financial crisis.

The fall in 2008 was the worse in the last 10 years but the current fall might be sustained for long given the dynamics of the world oil industry. It looks like the Saudis are aggressively using their deep pockets to preserve their oil market leadership position.

As the Organisation of the Petroleum Exporting Countries (Opec) prepares to meet towards the end of this month, there are no clear signs that it will curb output despite oversupply driven by lower demand in China and Europe and USA.

The world’s largest oil consumer, the US, has been boosting its oil production supported by shale production, through fracking or hydraulic fracturing to substitute imported oil for locally produced oil.

The US now produces 65% more oil than it did five years ago.

It now imports 3,1 million barrels of oil per day less, that is potentially over US$250 million less of oil revenue per day for the oil producing countries.

Nigeria, which, at its peak used to export 1,3 million barrels per day to the US, became the first victim of the US’s shale gas industry.

In July 2014, Nigeria stopped exporting crude oil to the US as Americans replaced imported oil with locally produced oil and gas. Other African producing countries may face the same fate that Nigeria faced with the US market.

For oil producing countries, like most Middle East countries (Saudi Arabia, Iran), Nigeria, and Russia, lower oil price means lower national incomes and this can have devastating macroeconomic impact. Russia generates at least 50% of its budget revenue from oil and gas.

The average break-even oil price is estimated at US$85, which would make a price below that unprofitable for most oil producing countries. Despite the potential loss in revenues, one wonders why the top oil producers are not worried much about the price fall.

Lower oil price is not bad for everyone. In a lower oil price environment, oil importing countries, like South Africa and Zimbabwe, would pay less for imported crude and related products. This would release income for other expenditures. According to the Economist, a US$10-a-barrel fall in the oil price transfers around 0,5% of world GDP from oil exporters to oil importers.

The World Bank calculated the 2013 world GDP at US$75 trillion.

If the oil price remains at the current level or decreases further, the downside risk being more stronger, the benefit of lower oil price would filter down the economic value chain, all others things being equal, through lower inflation, and would boost spend, which could support global GDP growth.

For the US and other shale gas producing countries, the recent plunge in oil price reveals an economic reality that with low energy prices, the US shale revolution is unviable.

The current oil market dynamics, led by Saudi Arabia, show that the balance of power still remains with the largest oil producing countries.

In the short to medium term, oil will remain a key energy ingredient despite efforts to diversify to other sources like natural gas. The unfortunate reality is that smaller producers and importers of oil are “forced” to stomach the swings in oil price.

*Nesbert Ruwo is an investment banker based in South Africa. He can be contacted on nesr@opportunvest.co.za – The Standard

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