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THE OIL PRICE CRASH WAS INEVITABLE
Marwan Salamah*
Dec 17, 2014
Four years ago, we published in www.asmainfo.com, the Arab Stock Market Analysis website, a technical analysis forecast of crude oil prices which indicated the likelihood of oil prices dropping in 2014 towards US$ 33 per barrel ! Technical Analysis is a mathematical statistical tool to identify trends and possible future prices and as such sees what the naked eye, used to empirical evidence, does not see.
Even a non-expert in technical analysis can see from the attached graph that the oil price rise between 2003 and 2008 was very high and steep thus inviting a steep downward correction. Another steep rise occurred in the period between 2008 and 2014.
However, there is a sunny side to this storm. The same analysis indicated the possibility of oil prices rebounding up towards the US$ 200 – 250 range in a few years. But, such a rebound would be conditional on the World’s presently weak economies regaining their vitality, no alternative to oil is discovered and no devastating regional or world wars occur.
As for the direct causes of the recent crash of oil prices, a number of negative events came into play in close proximity of each other. The first was the rapid commercial development of Shale oil production and Fracking, which elevated the U.S. to become the world’s largest oil producer and dramatically shrinking its dependence on oil imports (It is now forecast to become a net exporter of oil in a couple of years). The second was the inability of the European economies to shake off their post 2008 recessions in addition to the slowdown in the Chinese, Indian and the Third World economies. Thirdly, the oil producers continued their pre-recessions production levels throughout this period.
In short, the basic principles of Supply and Demand interacted classically to push oil prices down. Not only is the present supply of oil greater than the present demand, but it is also greater than the forecast demand for 2015. Naturally, the end-result would be a price drop.
But what caused the original meteoric rise in oil prices (between 2003 and 2008)? All indications point to the failure of the oil producers to keep up pace with the rising demand emanating from the robustly growing world economies, especially China and India.
In our view, the main reasons for the persistent shortfall of supply were: (a) Lack of spare capacity at most of the oil producers. (b) The depletion of oil reserves of some producers such as the case of Indonesia who became a net importer in 2009. (c) Disruption of oil production due to political turmoil such as Saddam Husain’s Iraq policies that led to the American invasion and the subsequent pseudo-civil war that is still raging. The Arab Spring also had its toll though at later stage. (d) Embargos as those placed on Iran for its alleged “nuclear bomb” which has hindered Iranian oil exports since 2006. (e) The negative effect of local oil consumption in the oil producing countries, which has shrunk the net quantities available for export to meet world demand. It is interesting to note that the local consumption of OPEC countries in 2013 was estimated at 8 million barrels per day (up from one million in 1965). This means that of the 30 million barrels per day produced by OPEC, only 22 million reached the export markets. All these factors contributed to the shrinking of oil production in relationship to the growing demand and pushed prices rapidly up.
However, the rise in oil prices carried with it a golden opportunity for the American oil producers who, at these high prices, were able to profitably develop and expand the hitherto unfeasible Shale oil and Fracking operations. Suddenly, the U.S. was free of its dependence on Arab and other oil. But the world economies weakened by the 2008 financial crash continued in their lethargic states and their demand for oil decreased in comparison to the existing supply.
Now, the producers faced a dilemma. To cut production and reduce supply but risk losing market share, or keep the market flooded and let the falling prices expunge the high cost producers. Saudi Arabia and OPEC chose to protect their market share and kept their production at the levels that existed prior to the price crash. By this, they seem to be targeting the American Shale and Fracking producers who are burdened with higher breakeven levels.
Saudi and OPEC are expected to eventual win this price war and some forecasts are indicating a gradual upward turnaround in oil prices by mid-2015. (Interestingly, somewhat similar strategies has been employed by OPEC a number of times since 1974)
While some readers may conjure at this stage the popular “Conspiracy Theory” that the West’s objective is to rob Arab oil wealth, it must be noted that wise nations act in their best national interests, and successful policies are flexible and adapt rapidly to take advantage of the constantly changing circumstances. The Industrial nations have had enough of seeing their economies suffer at the mercy of oil prices, and since the Seventies, they have actively been seeking ways to find alternative energy sources, cheap oil or ways to control oil prices and/or production.
The U.S. policy seems to have made it the biggest winner of this crisis. It has succeeded in creating a ceiling to oil prices, which guarantees the long desired stability for its economy. From now on, should oil prices dare rise towards the US$ 80 – 100 level, American oil production would again become feasible and resume pumping until prices moved down. That, in our opinion, is a chess master’s splendid move.
* General Manager of Orient Consulting Center
msalamah@occkw.com

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