At a petrol station in Tehran, Iran, 25 January 2016 (REUTERS/Raheb Homavandi/TIMA)
Crude oil is arguably the most important traded commodity. Despite efforts to switch to other energy sources, most countries — particularly in the West — still rely heavily on oil to fuel transport, heating and industry.
In the past, industrial nations had no choice but to continue importing oil even when the price rose dramatically. Today, the situation is reversed, as the huge increase in production by the world’s biggest user, the United States, has pushed crude prices to their lowest level in many years.
Low prices seem great for drivers who spend less to fill up their tanks. But price drops can hit oil-producing nations and companies hard, roil markets and undermine economic growth — ultimately hurting the same motorists, who might lose their jobs or see their retirement investments dwindle.
By Manuela Badawy
Oil prices have had a ruinous plunge in the past two years, and the odds for a strong rebound are pretty low.
U.S. oil prices have been hovering at around $30-a-barrel so far this year, the lowest in the past 11 years, and are likely to remain in that range as long as global supply continues to surpass current tepid demand.
Since June 2014, oil prices have been in a free fall, losing more than $75 a barrel, as the world oil market assimilates a surge in oil production from U.S. shale.
Shale oil and gas are hydrocarbons trapped in rocks; they are extracted using sophisticated technology that fractures rocks with pressurized water and chemicals. U.S. producers have drilled thousands of wells in the last decade, raising U.S. oil output to its highest level in three decades.
In turn, top oil producers such as Saudi Arabia, Iraq and other members of the Organization of Petroleum Exporting Countries agreed in 2014 to maintain high oil production levels to defend their market share while trying to push out high-cost producers around the world, in particular North American shale firms.
Consequently oil prices plummeted, driving one-third of oil and gas companies worldwide close to bankruptcy, according to a February report by Deloitte. Some producers have managed to stay afloat by cutting expenses, investments and selling assets, as well as by slashing dividends — once a major attraction to stock investors.
A stronger dollar helped push down demand.
The number of U.S. drilling rigs, viewed as a bellwether for activity in the energy industry, has fallen sharply, with active oil rigs touching the lowest level since 2009 in the week ending March 11. The number of natural-gas rigs fell to the lowest level since Baker Hughes Inc, an oil field services firm, began to count oil and natural-gas rigs separately in 1987.
Oil derrick in North Dakota (USA), 26 July 2011, (AP Photo/Gregory Bull, File)
The price drop intensified last year as the U.S. dollar appreciated 8.6 percent, according to the Wall Street Journal Index, while markets braced for the U.S. Federal Reserve to raise interest rates for the first time in almost a decade.
Oil is priced in dollars, so a stronger dollar has made it more expensive for buyers using foreign currencies.
Meanwhile, U.S. crude inventories are at their highest level in more than 80 years, keeping oil supplies — and prices — under pressure. Cushing, Oklahoma, a key storage hub and the delivery point for New York Mercantile Exchange crude futures, is holding 92 percent of its estimated working capacity as of September, according to data from the Energy Information Administration.
Oil producing countries have been hit hard by the weakness in oil prices and the global economic slowdown.
China’s economic slowdown has global consequences.
Venezuela, an OPEC member and once a rich nation that derives 95 percent of its income from oil export revenues, has seen its fiscal deficit burgeon, its inflation rate reach 270 percent and its currency depreciate. Now Venezuela needs around $110 a barrel of oil to break even.
The South American country is not alone.
Many commodity exporting countries are experiencing slow growth or recession, weak currencies and higher consumer prices as China, the world’s largest consumer of raw materials, decelerates its economy and switches from investment-led to service-led growth. That means China needs less from its suppliers, mostly emerging market economies.
Now OPEC producers are planning to meet with other major non-OPEC members such as Russia in mid-April to hash out an agreement to curb production in hopes of halting the price drop.
These countries had been in discussions since mid-February to limit their oil output as long as other big producers such as Iran comply as well. Iran has refused to agree on any deal.
These talks have pushed oil prices slightly higher in the past few weeks. But it is yet to be seen whether these talks will lead to supply cuts that would re-balance the oil market.
Manuela Badawy is an emerging markets and commodities editor for The Wall Street Journal. She is also a media and financial journalism trainer for the Thomson Reuters Foundation and an award-winning journalist with 17 years of experience working for Reuters News, The Associated Press, Colombia’s El Tiempo newspaper and Egypt’s Nile TV News.