The mean price of Brent oil fell to USD 90.60 on 10 October. Ural’s oil imported from Russia was quoted at USD 88.97 (1). Despite reassuring statements by some experts the price of crude oil continues to fall. The reasons behind the downward trend in crude oil price are presented below.
In spite of armed conflicts in Syria, North Iraq, Eastern Ukraine, still unstable situation in the Middle East and North Africa, including oil producing countries such as Libya and Egypt, oil price is going down. The price has been falling continuously since the end of June 2014. Recently, the price plunged to the lowest level in the past two years: in June 2012 Brent crude price fell below USD 90 after a short dip. Several factors have contributed to the dwindling of oil price.
A decrease in demand for oil, prompted by reduced global growth forecasts, is the first factor (2). At the same time the United States need less imported oil as their domestic supply of shale oil is up. Consequently, there is no upward pressure on oil price from the world's largest economy. The predicted slowdown in global economy growth combined with U.S. no longer reliant on oil imports has a direct effect on oil price expectations and, consequently, on the prices in spot transactions.
Oil supply is the second factor that directly affects the price of oil. According to Reuters, production volume by OPEC countries is the highest since November 2012 with Libya and Saudi Arabia as production growth drivers (3). The pressure on budgets of some oil producing countries (e.g. Venezuela and Iran among the OPEC countries) may prevent any understanding on production cuts and, consequently, the efforts to stop price falling may prove little effective.
The policies of Saudi Arabia and United Arab Emirates, top oil producing OPEC countries, will be decisive in that context. On the supply side, shale and other unconventional oil producers' efforts to maintain the rate of return on their investment in the U.S.A. and Canada may help to reduce the rate of oil price decrease.
The policies of investment banks, whereby they decided to sell their physical commodities trading branches, is the third equally important factor (4). The fact that most banks are no longer involved in physical oil trading, i.e. do not own oil nor are responsible for oil transport and storage, helps to keep oil price stable. Armed conflicts, like for example that in North Iraq, are less frequently used for bearish speculation. Moreover, an increasing oil supply at decreasing demand for oil (5), a low volatility in the absence of strong interventions by investment banks smooth the price drop curve and prevents a strong rebound upon reaching its minimum level.
U.S. dollar appreciation is the last but very important final factor that integrates the former ones and to some extent is connected with them. Improved U.S. current account (thanks to shale oil and gas production), economic growth stronger than in EU countries and voices from the U.S. calling the FED to raise interest rate, translate into dollar strengthening against all other currencies (not only the Russian ruble). As the dollar price is inversely correlated with that of commodities (including oil), oil price must fall.
For the time being there are no clear reasons for the oil price to decline any further, but we should not expect any spectacular price drops, similar to the one that has occurred in 2012. OPEC meeting slated for the end of November 2014 may act as a stimulus to reverse that trend. Increasing pressure from shale oil producers to keep the price is minimized by competition between the companies and the need to finance operations, but in a medium term may reduce oil output in the U.S.A. This aspect should be taken into account when considering potential oil price developments in the months to come.
Antoni Fałkowski
13.10.2014
1. Source: Neste Oil – after Thomson Reuters – last 5 days rolling average.
2. For example, global economic growth forecasts presented by IMF in October 2014
3. Source: REUTERS OPEC oil output hits highest since 2012 on Libya, Saudi-Reuters Survey – news of 30/09/2014
4. Morgan Stanley, JPMorgan Chase, Standard Bank of South Africa, Barclays are among the banks that sold their physical trading branches. Deutsche Bank, UBS and other banks have restrained these operations. Goldman Sachs is the only exception among major banks
5. See forecast reductions, as presented by IEA in August 2014
