20 January 2016

The price of a barrel under $30

Since June 2014, the price of a barrel of Brent has not stopped falling, passing from more than $80 to less than $30. The WTI has seen a similar change. This phenomenon is explained principally by the over-production of about 2 million barrels per day, which will continue to increase with the lifting of sanctions against Iran. The Iranian State will increase its immediate production capacity by 500,000 barrels per day, i.e. to 3.3 million barrels per day. And it has already announced a second increase of 500,000 barrels per day, in six months time, hoping to exceed 4 million by the end of the year. The overproduction situation is such today, that it becomes cheaper to use supertankers as a storage site at sea.

To this must be added, a mild winter with consequent low energy needs and a failed OPEC. The oil cartel has not succeeded to find an agreement to reduce its production and to raise the price. Several of its members such as Algeria, Nigeria and Venezuela are experiencing a very tense political situation. Marked by a high dependence on oil, a delicate geopolitical context and an explosive internal situation, these countries do not have any flexibility to reduce their production significantly, which would allow the price to rise.

infrastructures oil&gas de l'Arabie Saoudite

As usual, within OPEC, it is Saudi Arabia who assumes the role of regulator. Its considerable reserves, its high production (12 million barrels per day at maximum) and its extremely low re-sale price (less than $10 on Ghawar, the onshore site which produces more than 5 million barrels per day), usually allow it to play this shock absorbing role. The Kingdom is situated in a complex geopolitical crossroads, however. The threat from the Islamic State, the failure of American support during the Arab Spring and its antagonism with Iran, the Shiite rival in the region, encourages it not to give any concessions to other oil producing countries without obtaining serious compensation.

The first consequence of such a low oil price is the freezing of investments, which in the long run will restrain production. Mechanically, the barrel will start to increase when the production stocks diminish. The whole problem is to know when this will happen. In addition, such a recovery can accelerate or slow down depending upon the level of tension in the exporting countries. The expected defeat of Nicolas Maduro in Venezuela, a change of regime in Algeria or a worsening of the conflicts in the Middle East could in fact, help to raise prices. Inversely, a lowering of tensions would contribute to slowing a recovery rendered inevitable in the long term by the freeze of investments in the sector.

In the United States, the risk of failure is great for a number of shale oil producers. Several banks such as Citigroup and Wells Fargo, have already provisioned more than a billion dollars in view of numerous payment defaults. For more than ten years, the shale oil sector has been at the origin of the American recovery, notably in terms of employment and investment. Paradoxically, the lowering of the price of a barrel could also have a recessional effect on the American economy and therefore indirectly, on the rest of the world.