Global crude oil prices have fallen significantly over the past few months. Brent crude for November delivery for example settled at US$94.67 per barrel, a 16% drop for the quarter and its lowest for 27 months. West Texas Intermediate also last month fell below US$90 per barrel ending 12% lower for the third quarter.
Such declines however, bear only mixed fortunes. While manufacturers and other consumers may welcome the relief, crude oil producers especially those engaged in unconventional resources (such as shale) and complex terrains (such as the deep offshore or the Arctic) may not be so welcoming; and that is because the falling crude oil prices may test the upper range of breakeven prices for some of these producing fields.
At present, there are three principal drivers for global crude oil prices:
The 2008 global economic crises saw a decline in the world’s total petroleum consumption; among member-countries of the Organization for Economic Cooperation and Development (OECD) however, that decline began well in advance, in 2005 (Figure 1).
A sustained rise in oil prices led to the introduction of higher efficiency and conservation measures such as Renewable Fuel Standards and Fuel Efficiency Standards which further reduced consumption.
Global rebound from that recession has been modest and that has led to sluggish growth in demand for petroleum, which is still the dominant energy form for powering the world’s economic wheel. In the United States, rebound has been slow and factory activity reports for September indicate an uneven expansion. For the European Union, growth has been fragile and the prospects for 2015 are modest. France and Germany are the two European economic powerhouses but in September, factory activity shrank for the first time in 15 months in Germany while France saw a contraction for the fifth month running. In the United Kingdom, manufacturing activity fell to a 17-month low in September.
Rising emerging market demand for petroleum was expected to countervail the decline in developed economies, however GDP growth in this economic group has slowed; according to the International Monetary Fund, IMF, GDP growth in emerging markets slowed from 7% during 2003-2008 to 6% during 2010-2013 and is expected to further fall to 5% during 2014-2018. Even the Asian economic giants have seen a measure of slower economic growth. China, on concerns about slowing economic growth, recently cut mortgage rates for the first time since the 2008 crises, in an effort to bolster a flagging housing market. India and South Korea have also witnessed contractions in manufacturing activity.
The steep rate of crude oil production increase in the United States ― in addition to increases from Organization of the Petroleum Exporting Countries ― has contributed significantly to the current excess global supply. Such is the contribution from producers outside the Middle East that the current ISIS crises in Iraq has had little if any effect on global crude oil prices. According to the Energy Information Administration, total oil supply by the United States exceeded those of Saudi Arabia and Russia to record the highest value for a country in 2013 (Figure 2).
According to Platts, the estimated surplus of global oil supply over consumption for 2014 is currently about 800,000 barrels per day. That surplus is set to increase as OPEC members prepare for a price-reduction battle in order to protect their market share. The net effect of the supply glut has been downward pressures on prices.
Exchange rates for the United States dollar with regard to major global currencies have also impacted crude oil prices. The U.S. currency strengthened to a two-year high against the Euro and a four-year high against several major currencies. Since crude oil is bench-marked in United States dollars, the effect of that strengthening has been to make the commodity more expensive, exerting downward pressures on demand and hence prices.
All said, given the current levels of oil oversupply and the phlegmatic rates of global economic activity, oil prices will most probably remain comparatively low in the short to medium term. Some analysts expect a further decline of about US$10 per barrel from current price levels. This will test the profitability of cost-intensive producers. Breakeven prices for tight oil producers in the United States for example are estimated to be between US$65 per barrel and US$85 per barrel. For the Canadian oil sands, the values are US$75 per barrel for steam-assisted gravity drainage projects and US$100 per barrel for mine upgrading capacity projects. The implication is that some ongoing projects may be forced to shut down while some proposed ones may be shelved.
While these conditions may constitute the necessary spur for a future price rebound, the expected tenure of the current price regime remains uncertain.