Low oil prices mean Keep On Truckin'
02 September, 2015
While share markets around the world have been volatile this pales into insignificance compared to the gyrations in oil prices...
Yes it's been a wild ride. Over the past three nights oil prices have spiked by 27%, the biggest rally since the invasion of Kuwait in 1990. Of course over the last year oil has fallen by 50%. The month by month movements have been enough to give you whiplash. Typically analysts describe a 20% gain as a bull market and a fall of 20% a bear market. On that measure we have had three bull and three bears markets in oil over the past 12 months.
What is happening to oil?
For any budding economics students out there, this is a classic case study in supply and demand. In short, more supply and less demand means weaker prices.
The supply side of the story started with the shale oil industry in the United States which, from nothing, was pumping over 5.5m barrels a day at its peak. You would expect that to drop oil prices but the unusual twist is that other countries, like Saudi Arabia and Russia, responded to lower prices not by pumping less oil, but by pumping out more, and that put increasing downward pressure on oil prices.
Presumably with weaker growth in China and the emerging market economies demand isn't looking that flash either...
Normally lower prices would equal higher demand for oil. But it isn't really doing that this time around. Many of the emerging market economies have been large consumers of oil and are reliant on other commodity exports to fuel economic growth, think raw materials like coal and copper. With commodity prices generally weak, economic growth has been soft in these countries. This hurts demand for oil. A number of analysts also worry about demand for oil from China and what this means for the demand for oil around the world.
What is the outlook for oil prices?
The global investment bank Goldman Sachs estimates that the current oversupply of oil is around 2m barrels a day over and above current demand. At the moment this oil goes straight into storage tanks dotted around the world. At some stage, those spare tanks will run out and at this point producers will be forced to reduce production. When they do this prices will stabilise, and stop falling, at least in the short term.
Longer term there has been a real change to the dynamics of the oil industry. Shale oil deposits are hard to shut off once they are going. But the flip side is if you want to produce more oil, just drill another well and that can be done very quickly. This dynamic means deeper potential lows in prices and if prices start to rise, more production can begin very quickly. Goldman Sachs argues a "lower for longer" outlook for oil as a result of this dynamic.
What does this mean for us? As long as that kiwi dollar doesn't keep falling it looks like low oil prices at the pump will be here for a while.