Top Factors Undermining Any Oil Price Recovery

Courtesy of Alexis Arthur of OilPrice.com

Global oil prices have returned to a state of flux. This is hardly news to any who follow the oil markets closely and yet prices continue to drive international headlines.

While oil prices are notoriously difficult to predict, it has failed to deter the speculators. There are those warning that the latest dip is a precursor for $40 a barrel, a catastrophe for oil markets in some minds. On the other end of the spectrum are the optimists betting on a return to $100 by 2020. The World Bank has taken a typically middle-of-the-road approach, with forecasts of $57 a barrel in 2015.

That said, given Iran’s potential revitalization, Russia’s murky outlook, and U.S. shale supply limits uncertain, prices will be responsive to supply and demand trends; at least in the short to medium term.

The Iran deal could be a game changer for global oil supply. Lifting oil sanctions could pave the way for foreign capital to return to the country, contributing to a resurgent Iranian oil industry.

The Iranian oil ministry is optimistic about the nation’s recovery, predicting 400,000 barrels per day of exports almost immediately and an additional 600,000 barrels per day over six months.

Such a swift return is unlikely.

Iran was once the second largest oil producer in OPEC before Europe banned purchases of its crude in 2012. Since then, oil production has declined from around 3.6 million barrels per day in 2011to just 2.85 million barrels today.

The nation is still OPEC’s fourth largest producer but its output is far closer to Mexico’s than Saudi Arabia’s. Oil exports have declined by 1 million barrels per day during this time.

Iran has significant onshore and offshore reserves but has lacked the technical capacity and capital to develop them in line with its ambitions.

Executives from Shell have reportedly met with Iranian officials to express their interest in re-entering Iran. U.S. companies, meanwhile, risk losing out unless Congress decides to lift its own decades-old restrictions on dealing with Tehran.

In an era of low oil prices, Iran has among the cheapest oil to produce at an estimated cost of $5 – $10 per barrel. The nation’s strategic geographic position between European and Asian markets is also attractive. European and Asian companies – unfettered by the limits on their U.S. competitors – will no doubt take advantage of this high-risk but high-reward opportunity.

Still, a return to 2011 production levels will take time, as will its impact on global oil supply and prices.

That Russia’s economy is struggling is no secret. But in spite of severe economic and political crises, Russia’s crude output has continued to grow. Earlier this year, Lukoil Vice President Leonid Fedun warned that Russia’s output could fall by 800,000 barrels per day. A lack of investment may indeed eventually catch up with Russian production but in the meantime, like the U.S., oil supplies will continue to rise.

U.S. oil producers have also defied expectations as shale oil production continues apace. Efficiency gains and cost savings have allowed innovative producers to elude assumptions about the price floor for shale, for the moment at least.

Of course, all is not rosy for shale producers. Tens of thousands of oil workers have lost their jobs, companies have lost value, and some have gone bust. And the question remains how low they can really go and how long they can last – particularly those already incurring losses but holding out in the hope of a price recovery.

Still one would be foolish to dismiss shale producers’ resilience and without a doubt the U.S. will remain a key player in the global oil supply outlook.

In the longer term, another factor too often left out of the debate is the knock-on effect of slashed exploration budgets across the oil majors and national oil companies. Projects have been suspended, and companies are demonstrating increased caution in frontier – high risk – areas. This is a trend already apparent in the Western Hemisphere as Brazil, Mexico, Argentina, and others jockey for a smaller pool of exploration funds.

But this is just the supply-side of the equation. On the demand side, the International Energy Agency’s latest oil market report shows demand slowing in 2016. This would indicate a continued resistance to oil prices returning to anything resembling the pre-2014 fall.

Overall, the trends may be clear but the prices are not. For planning purposes alone, the only thing worse than low oil prices is market volatility and uncertainty will continue to rule in the short to medium term. In the meantime, oil price speculation – while entertaining – is a poor reflection of market reality.

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