The Slippery Slope of Plunging Crude Oil

OPEC learned valuable lessons in recent years. When oil prices are high, there is simply too much incentive for the opposition to want to claim a slice of the pie. And that’s precisely what happened when OPEC enjoyed the benefits of oil prices over $100 per barrel. The enticement for shale oil producers was simply too strong and a virtual explosion of interest in oil drilling activity developed in the US. Crude oil imports from OPEC went in the opposite direction to that of US crude oil production. And the numbers speak volumes: OPEC simply cannot afford to allow prices to rise too high because it benefits the opposition. Take a look at the following chart to gain a clearer picture of the dilemma facing OPEC – the world’s most significant marginal oil producer. 

The world demanded significantly less oil from OPEC countries when the price was too high ($100+) since it was viable for other producers to enter the market. For OPEC the opposition came in the form of US shale oil producers – WTI crude oil. As output from WTI producers hit the markets, OPECs share diminished along with its profitability. When OPEC members met in early December 2015 to discuss the possibility of production cuts it was decided that production would continue unabated.

This has led to where we’re at today:

Oil prices are hovering around $35 per barrel and slipping fast. Already, oil hit a 12-year low when it was barely trading above $32 per barrel in early January 2016. That it managed to regain some ground in the aftermath is notable but not substantial. Oil merely endured a technical correction from its multi-year low and it will likely continue to hover around the $30 range, possibly even decline to the mid-$20 range in 2016. Consumers around the world are not complaining: US gasoline prices at the pump are at approximately $1.90 per gallon and further price cuts may be in the offing if Brent crude and WTI crude prices keep declining. 

US crude oil producers have been hammered by persistent weakness in crude oil prices. The latest economic data indicates that the total land rig count in the US decreased by 37 for the week ending Friday 8 January 2016.  There was a reduction of 30 in the horizontal rig count, making the declines the biggest in 10 months for WTI crude oil producers. One of the most important developments was the end of all operational rigs in the Fayetteville Shale region. Here are some other notable reductions in operational rig counts across the US:

• – 3 for the Bakken rig count
• -7 for the Permian rig count
• – 4 for the Eagle Ford rig count
• -14 for the Bakken-Eagle Ford-Permian HRZ rig count

Typically, the loss of oil rigs diminishes the overall supply of crude oil which is supposed to raise the price through the demand/supply mechanism. However, in the US the low-cost oil producing companies are taking over the market share ceded by the higher cost oil producers. Eventually, the shuttering of too many oil rigs in the US will result in a drop in production capacity and a rise in the price of crude but we are not quite there yet. The excessive oversupply and the imminent entry of Iran with up to 500,000 bpd of crude oil are factors weighing heavily on the low price of crude oil. 

When oil was trading at over $100 per barrel, car companies and innovators were feverishly attempting to find solutions with alternative sources of energy. There have been several advances in this field but none of them has taken off quite yet. Tesla Motors has been at the forefront of this type of innovation with the construction of some 500K electric cars by 2020. Toyota of Japan is eyeing hydrogen-powered vehicles, and back in the US Ford Motor Company is also looking at measures to develop and mass produce electric vehicles. OPEC and WTI oil producers are aware that change is imminent and that global demand for crude oil will not necessarily recover to its former glory – or even close to it. OPEC would likely be highly satisfied if oil prices were to double from their current levels in the medium-to-long-term. A price in the region of $60 appears overly generous at this juncture but that’s precisely what we could be looking at within 2 years.

This article was written by Idan Levitov, Head analyst for anyoption.com