The slippery slope that oil is skidding on is steepening. Prices hit a six-month low on the first trading day of August, extending five weeks of losses. At noon in New York, West Texas Intermediate was trading at $46 a barrel, with Brent trading at $50/bbl. Speculative bets on U.S. oil futures are near a five-year low. Prices are being hurt by a slowdown in demand in China, overproduction by OPEC, and news that oil rig counts in the U.S. are increasing.
July was the worst month for crude prices since the height of the financial crisis in 2008. The price for West Texas Intermediate plunged 21% for the month, and Brent crude stumbled to an 18% loss. Prices are down from the recent June 2014 high by 57% and 56%, respectively.
Oil companies are feeling the pain, and it isn’t limited to the small shale operations. Exxon reports that lower oil prices slashed their profits by 50% in the second quarter of 2015, and Chevron posted the lowest profits in over 12 years, as net income compared to a year ago fell by nearly 90%
What’s Weighing on Crude Prices?
Several factors are involved in the current rout in oil prices, but it comes down to (1) supply, and (2) demand.
Deathmatch in the Oil Patch
The “Fracking Revolution” in American shale oil fields started in 2013. With oil over $90 a barrel, these operations made a profit, despite the higher operating costs. Shale fracking set off the second-largest oil boom in history, and propelled the U.S. to be the world’s largest oil producer, bypassing Saudi Arabia. As OPEC saw its market share shrink and prices drop, they decided to drive their low margin competitors in the shale fields out of business.
After announcing in November 2014 that they would not reduce production, but rather fight to retain their market share, oil production in Saudi Arabia jumped from 700,000 barrels a day to 10,300,000 barrels a day by March. At the same time, U.S. oil production continued to hit 30-year highs. The price war devastated the shale patch, as rigs were idled, exploration curtailed and workers laid off. Active rigs in the U.S. fell from 1,609 in October 2014 to 664 in July 2015. U.S. oil production dropped to under 10 million barrels a day.
Throwing another monkey wrench into the mix is the talks between Iran and the Major Powers over curtailing its nuclear research program. Iran has the world’s largest fleet of supertankers, filled and ready to start delivering oil as soon as international sanctions are lifted. The government in Tehran has announced that it will boost production to 1 million barrels of oil a day within a week of sanctions being lifted.
Global Growth, Isn’t
As oil producers race to drown their opponents in their own supply, a sputtering global economy means that there is less demand. China is the world’s leading consumer of raw materials, but a plummeting stock market and turmoil as it tries to shift its economy from an export-driven model has meant far lower demand for commodities of all sorts—including oil. “China is where the action is. And if China has a hard landing, so does the global economy,” said SouthBay Research’s Andrew Zatlin, cited in a WSJ MoneyBeat. report.
Europe is still struggling to recover from recession, and high numbers of unemployed in the southern nations of the Eurozone continues to stifle demand. The U.S. is struggling with a glut in crude supply, to the point where it is running out of places to store it.
So, what does the future hold for oil prices? Most analysts say that things are not going to get better anytime soon.
Royal Dutch Shell Plc is preparing for a “prolonged downturn,” in a recent statement. The oil giant is laying off 6.500 workers and reducing capital investments by over a billion dollars. Shell officials now see prices remaining low for at least the next three years, abandoning a forecast in April that called for $90 oil by 2018.
With its crude oil selling at such low prices, Saudi Arabia has unveiled plans to greatly expand its refining capacity to boost profits. Since the state owns both the major oil company and refineries, these new refineries will basically be getting their raw input (crude oil) for free. This will give the operation a huge margin on the finished product.
The Saudis also announced that they will reduce production this autumn, as seasonal demand slackens, but still keep production over 10 million barrels a day in order to force more low-margin competition out of business.
Any support for prices from reduced production is likely to be muted, however, as the U.S. dollar is poised to strengthen even more when the Fed raises benchmark interest rates. Low gasoline and heating oil prices are welcomed by a U.S. public striving to get by, but these low prices will also keep inflation lower than the Fed wants. American economists are in the peculiar position of wanting higher prices and a weaker dollar to fuel a recovery.