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Oil prices at two year lows likely to remain weak
September 28, 2014, 12:42 pm
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A combination of sluggish demand and oil glut will keep prices at current levels

The price of crude oil has fallen to its lowest level in over two years, in line with current economic conditions. Oil prices have been trending down since mid-June this year, when Brent crude was priced at around $115, to around $95 per barrel today. It will be nearly a month that Brent crude is trading below $100 per barrel. Prices hovered around the $110 level for half a decade following the global financial crisis.

In that period, the barrel of Brent oil traded below $100 only for a few days in two short periods of time in 2012 and 2013. The recent dip reflects an adjustment in the misbalances in the oil market rather than a reduction in geopolitical risks.

Compared to the start of the year, global oil supplies have increased considerably, and the glut of oil has driven crude oil prices down. According to the US Energy Information Administration (EIA), global supply of crude oil and liquid fuel reached all-time highs of 92.6 million barrels per day in August. Stable oil producers, such as Gulf Cooperation Council (GCC) members (and more specifically Kuwait and the UAE) have contributed to that output rise. Kuwait increased crude output from 2.8 million barrels per day at the start of the year to 2.9 million in September, while signaling that it may rise to 3.0 million barrels per day next month. UAE’s oil production also rose this year from 2.7 to 2.9 million barrels per day. In contrast, market leader Saudi Arabia cut its production this month by close to 5%, the largest reduction in two years, trying to support prices.

But a key differential factor in this period in that ‎volatile producers in Africa and the Middle East experienced a spike in production. Nigeria and Angola accounted for nearly 60% of the increase in oil output last month, and despite a surge in violence in Iraq and Libya, oil production rose in those two highly unstable countries too. Saudi Arabia’s cut was not large enough to increase prices, and further reductions are unlikely given the high level of spending of the country. Stockpiles also increased in the US. Given the volatile and uncertain nature of Africa and the Middle East, a gradual sustained increase in supply is unlikely in those regions.

For instance, Libya’s largest oil field was temporarily shut down in September due to rising violence in the region. However, if high global production was to continue, an agreement among petroleum exporting countries (OPEC) to cut output will become a real possibility. The last time OPEC unilaterally cut supplies was in 2008.

A stronger economy would also ‎push up oil prices higher. However, global demand remains weak. The largest economies after the US – the euro zone, China and Japan – decelerated this year. The US is not importing as much oil as it used to, mainly due to a surge in domestic production. Global growth is not expected to rebound this year, and this is a major factor behind oil prices remaining subdued.

Three major energy agencies cut their forecasts for global oil demand in the past month. The strength of the US dollar also exacerbates the oil demand slowdown as it makes oil products more expensive for other importers. OPEC has already indicated that it may cut output as supply is outpacing demand for oil. However, even an OPEC production cut may still not be enough to drive prices back to levels witnessed in the last few years.

The primary upside risk to oil prices is a deterioration of the crisis in the Middle East. Otherwise, it is very likely that oil prices will hover at or below the $100 mark due to a combination of sluggish global demand and a lack of coordination by OPEC members.
 

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