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Expecting the return of high oil prices? Think again

November 3, 2015

It has been almost a year since oil prices hit new lows after OPEC’s November 2014 decision not to cut production.

Speculation by oil companies, industry analysts, investors and financial experts that oil prices will rebound have not come true, and prices continue to dip regardless of the few attempts of oil price recoveries.

Since the beginning of 2015, oil prices have seen a few modest recoveries that were mostly due to falling rig counts, U.S. oil production decline, weakness in the U.S. dollar or, lately, the escalating conflict in the Middle East. However, those recoveries were short-lived.

A recent example of such recoveries in oil prices was the latest rally of early October, when WTI jumped from mid-$40s per barrel to $50 per barrel following the news of falling rig counts and the U.S. oil production decline. Many O&G companies and analysts put their hope in this rally and saw it as the first signal for a long and lasting recovery in oil prices. But, unfortunately, the rally did not last for long.

The following week, as the oil markets started to digest ‘what happens next’ and the fact that the underlying fundamentals of supply and demand were unchanged due to continuous growth of supply from other producers – mostly OPEC’s members such as Iraq, UAE, and Iran – oil prices retreated again. WTI dropped from $50 per barrel back to $47 per barrel.

What the latest rally in oil prices meant

It is undoubtedly true that October’s rally and how it ended was much of an eye opener for many of those who were still hoping for a rebound. It made it clear that ‘instead of hoping for a rebound, oil companies should learn how to make a living at oil prices level of $40 per barrel or even less’.

Besides that, it is now clear that the issue is more about who will win the market-share cold war, rather than who must balance the supply and demand. OPEC has been always playing its role to balance supply and demand, but this time it chose to pursue market-share. Therefore, supply and demand fundamentals are only being used as a weapon in this market-share cold war.

October’s rally also indicated that it will be unlikely to see high oil prices again as ‘Lower for Longer’ oil price strategy is the new normal in the oil and gas market.

The new normal: ‘Lower for Longer’ and why

It is now without doubt that OPEC’s November meeting was a pivotal moment for the oil and gas industry. A moment where we all look back and ask, could things go back to the way they were before November 2014?

The answer to this question is definitely a big ‘NO’, and I believe by now, many of those who were expecting things to get better and prices to increase to at least $70 per barrel have realized that oil prices are unlikely to go up to that level at least for the short-term. And that means accepting the ‘Lower for Longer’ oil price strategy as the new normal in the oil market.

OPEC’s current strategy to pursue market-share over stabilizing the market is seen as response to the threat posed by U.S. shale oil producers. By pursuing market-share and keeping its production level sustained resulting in collapsing oil prices, OPEC aims at squeezing high cost U.S. shale oil producers out of the market, and therefore putting an end to the threat posed to its market share.

Besides that, the main reason why lower for longer oil price strategy is going to be the new normal for at least the short-term is the fact that high oil prices is the main reason for the current downturn.

How high oil prices led to the current downturn?

When higher oil prices were sustained for a long term, it provided an excellent breeding season for few advanced technologies used to develop shale oil such as hydraulic fracturing and horizontal drilling to nurture and flourish over the past years.

The use of such technologies increased the U.S. shale oil production to over 4.72 MMBD at the end of 2014 down from 1.24 million barrels daily (MMBD) back in 2007. The new U.S. oil output supplied the domestic market and pushed out oil imports from traditional suppliers such as Saudi Arabia, Nigeria and Algeria that suddenly needed to find new market for its oil.

The oil production introduced by shale oil producers slightly glut the market at the beginning, and the call was for OPEC to play its role to stabilize the market by increasing/decreasing its production output. It seemed that U.S. shale producers were certainly optimistic about OPEC’s reaction. But this time, it was different. OPEC was facing hard choices.

Playing its role to stabilize the market by reducing its oil production meant losing its market-share for U.S. shale oil producers which OPEC cannot afford to do, because the long term consequences for such decision meant losing its market-share and influence on oil prices. As a result, OPEC decided to pursue market-share strategy instead of stabilizing the market.

OPEC’s decision marked the beginning of market-share cold war and drove oil prices down to levels not seen since the depths of the 2009 recession. By following such a strategy, OPEC aims to protect its market-share, force high-cost oil producers such as shale oil, and deepwater out of the market, and let the market balance itself.

Why no increase in oil prices any time soon?

Looking back at what have been discussed above, it is crystal clear that the roots to the current downturn lay mainly on the sustained high oil prices for a longer term before November 2014. High oil prices means sustained and economical production and development of shale oil not only in the United States, but also in China and other counties as well, and this means OPEC was losing its influence and market-share.

Therefore, it is expected that OPEC will stick firmly to its strategy leading to sustained low oil prices for a long time. The result will be squeezing oil rivals such as shale producers out of the market, reducing investment in technology and innovation and hindering the development of new shale oil projects which will ultimately decrease shale oil production and discourage any future investments in such projects.

What makes the situation even more certain is the expected increase of Iranian oil production after lifting the sanctions. Furthermore, Russia, Iraq, Libya, Kuwait and UAE are working aggressively on increasing their oil outputs. On the other hand, global oil demand is lagging behind due to slow economic activities. Therefore, lower for longer oil prices are here to stay for quite some time but surely not for an extended period of time.

We have learned from the history of oil and gas industry that neither higher nor lower oil prices are sustainable over a long period of time. The current low oil prices will discourage upstream activities such as exploration and production- affecting the supply side of the equation and consequently leading to higher oil prices. But it is hard to tell at present when- or how much- that increase in oil prices is going to be.

By Alahdal A. Hussein

Source: Oil Voice

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