The Oil turmoil

The following article is based on my own interpretation of the said events. Any material borrowed from published and unpublished sources has been appropriately referenced. I will bear the sole responsibility for anything that is found to have been copied or misappropriated or misrepresented in the following post.

Palash Sinha, MBA 2015-17, Vinod Gupta School of Management, IIT Kharagpur

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Price of a barrel of oil, which has fallen more than 70 percent since June 2014 is the most talked about thing from the past couple of years.Prices recovered a few times last year, but a barrel of oil has already sunk this year to its lowest level since 2004. Executives think it will be years before oil returns to $90 or $100 a barrel, a price that was pretty much the norm over the last decade.

So, what are the major causes which are affecting the situation? Firstly, Demand is low because of weak economic activity, increased efficiency, and a growing switch away from oil to other fuels. Second, turmoil in Iraq and Libya—two big oil producers with nearly 4m barrels a day combined—has not affected their output. The market is more sanguine about geopolitical risk. Thirdly, America has become the world’s largest oil producer. Though it does not export crude oil, it now imports much less, creating a lot of spare supply. Finally, the Saudis and their Gulf allies have decided not to sacrifice their own market share to restore the price.

The main effect of this is on the riskiest and most vulnerable bits of the oil industry. These include American frackers who have borrowed heavily on the expectation of continuing high prices. But the greatest pain is in countries where the regimes are dependent on a high oil price to pay for costly foreign adventures and expensive social programs. These include Russia and Iran. Optimists think economic pain may make these countries more amenable to international pressure. Pessimists fear that when cornered, they may lash out in desperation.

In this situation “At the moment the best possible feasible proposal is to freeze at the level of production of January,” this recent statement by Mohammed bin Saleh al-Sada, who holds the rotating presidency of OPEC came as a relief to the oil exporting countries. According to him oil prices could move back to above $50 a barrel within a year. Recently Saudi Arabia also acceded to the fact that they should cut supplies so that the disequilibrium can be mended. As the oil price is going down further it will be interesting to watch how OPEC and other oil exporting countries tackle this situation in recent years.

 

 

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