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WHY OIL IS SELLING WELL ABOVE $80 PER BARREL By: Esan Mascot Ogunjemiyo

Esan Mascot Ogunjemiyo

The surge in crude oil production in the USA over the last three years and the likelihood that the shale-fracking techniques in the USA will be exported to other countries in Europe and Asia, made some analysts to predict over supply of crude oil that may lead to prices as low as $60 per barrel.

Those predictions may not have taken into account the forces of demand and supply on prices. Though I am not that bullish on oil prices, below are some reasons why we are unlikely to see a sustained crash of crude oil prices less than $80.

1. Depletion
Oil, like other non-renewable resources undergo depletion (natural reduction) over a period of time. Production in wells, fields and reservoirs decline depending on the nature of reserves. Fracked wells which create the current oil boom in the USA decline very fast. For instance, a newly fracked well producing 1,000 barrels a day, could decline 60%, in the 2nd year, 35% by the 3rd and 15% by the 4th.
Even if the average decline rate worldwide is just 5%, that means the industry needs to develop a new Saudi Arabia every two years, just to stay even.

2. Near Monopoly of oil in as Transportation Fuel
Research has shown that motorist consume more fuel when prices are low and vice versa. Electric cars/vehicles are fast becoming as convenient and efficient as internal combustion engine (the conventional) cars/vehicle. The high cost of liquid fuel has helped in making electric automobile business profitable. Tesla, an automobile company set up solely to manufacture electric car, declared profit in 2013. Despite this huge breakthrough there’s not enough new Priuses or Teslas on the road to reduce the monopoly of oil for now: if petrol prices fall, demand for oil will increase.

3. Demand Growth in Asia and Africa
Although demand for crude oil is dwindling in Europe, the growing middle class in China, India, Nigeria and other emerging economies of Asian and Africa come with increasing appetite for energy consumption.

4. Inventories
When prices are low import dependent country tends to increase their strategic reserves. For instance, in 2012 China increased the rate at which it built up its oil inventories, adding 240 million barrels in 2012.

5. Rising Develop and Production
About 95% of USA production particularly shale oil is done at a marginal cost of about $71 a barrel. Unless new technology help to drive down cost over the longer term a corporation will not survive if its marginal production costs are higher than the going price of crude. In the conventional play environment such as Niger Delta, a common saying in the industry cycle is that the era of “easy find easy produced” oil is gone.

6. Stripper wells or Marginal Field
Stripper wells are marginal wells that produce less than 15 barrels per day. In the USA alone stripper wells produce up to 1 million bpd oil when the price is high. Production costs are often high on stripper wells because they produce a lot of water along with the oil, and water can be expensive to treat and get rid of, especially when there are no economies of scale. Most of these wells become uneconomic and may stop production at oil prices less than $90.

7. OPEC Influence
OPEC member countries produce about 30.4 million barrel per day amounting 40% of the total world output. Most OPEC nations require prices above $80 per barrel to balance their budgets and maintain high government spending. They will therefore favour output cut and adhere to quotas in order to get prices back up. Saudi Arabia the world largest producer and exporter demonstrated high level of disciplined in 2009 when oil prices crashed it cut production by 1.5 million barrels per day. Saudi also tends to export less when prices are low.

8. Crisis in Oil Rich Countries
Unrest in any of the oil producing countries cause speculators to engage in panic buying which creates abnormal demand that spikes up prices. The reason why the production boom in the USA could not influence international market prices is largely attributed to the Geo-political tension and unusual situations in countries like Iraq, Libya and Nigeria. In Iraq, militant group (ISIS) has raised alarm bells regarding oil flows from the second-largest Producer of OPEC (after Saudi Arabia). Infrastructure woes, theft, legislative uncertainties and sabotage have largely discounted Nigeria’s contribution to the world’s oil supply Nigeria whereas political unrest and protests in Libya have led to reduced oil production. The escalating tension between Russia and western caused by the crisis in Ukraine will affect prices.

In conclusion, the reasons discussed above are enough to tighten global oil supply by close to 2 million barrel per day if Brent crude were to fall to $80 — that would be enough tightness to bring prices back above $90.

© 2015 NAPIMS
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