Reasons for Oil prices drop and the repercussions on the Global markets08/01/2015

White PaperDomain: Energy and Resources

Chandan Kar ; Gitanjali KarDomain

Chandan.kar@tcs.comGitanjali.kar@tcs.com

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Table of Content

Abstract...........................................................................................................................................................................4

About the Author............................................................................................................................................................4

About the Domain...........................................................................................................................................................4

1. The Current Situation..............................................................................................................................................5

2. Why High Oil Supply and Low Demand ?.................................................................................................................6

3. The Repercussions!!................................................................................................................................................7

4. References...............................................................................................................................................................8

5. Glossary...................................................................................................................................................................8

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Abstract

This Paper focuses on the various reasons leading to a global OIL Price Dip and will conclude with repercussions due to the price dip.

About the AuthorChandan Kar is the Account manager for BP account with in TCS ASSURANCE

Gitanjali Kar is currently working as a Test Manager for BP account with in TCS ASSURANCE

About the DomainEnergy and Resources Domain

The energy industry is a generic term for all of the industries involved the production and sale of energy, including fuel extraction, manufacturing, refining and distribution. Modern society consumes large amounts of fuel, and the energy industry is a crucial part of the infrastructure and maintenance of society in almost all countries.

The petroleum industry, including oil companies, petroleum refiners, fuel transport and end-user sales at gas stations

The gas industry, including natural gas extraction, and coal gas manufacture, as well as distribution and sales

The electrical power industry, including electricity generation, electric power distribution and sales

The coal industry The nuclear power industry The renewable energy industry, comprising alternative energy and sustainable energy

companies, including those involved in hydroelectric power, wind power, and solar power generation, and the manufacture, distribution and sale of alternative fuels

Traditional energy industry based on the collection and distribution of firewood, the use of which, for cooking and heating, is particularly common in poorer countries .Source Wikipedia

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1. The Current SituationEach one of us is perplexed & wondering as to how the price of Brent crude that was around $115 per barrel in June 2014 has fallen sharply to $ 52 per barrel? The current situation with oil price is not as complex as perceived to be. The answer to this lies in one simple statement. Increased supply & Decreased demand equals lower price .This is well explained by the well-known economic model “Theory of supply and demand”. It is the model for determining the price in a market.

The laws as per Theory of Supply and Demand is as illustrated in the below Graph No. 1 & Table No .1 –

Graph No .1 –Supply Demand Curve

Law Demand Supply ResultLaw 1 Demand: Increases Supply : Unchanged Shortage Occurs leading to a

higher Equilibrium priceLaw 2 Demand : Decreases Supply : Unchanged Surplus occurs leading to a

Lower Equilibrium pricesLaw 3 Demand : Unchanged Supply : Increases Surplus occurs leading to a

Lower Equilibrium pricesLaw 4 Demand : Unchanged Supply : Decreases Shortage Occurs leading to a

higher Equilibrium price

Table No.1 – Laws in Supply Demand theory

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2. Why High Oil Supply and Low Demand?

To comprehend the present, we need to have a view in to the past. During mid-2000 years, oil prices were going up as the global demand for oil increased significantly. Especially demand was surging to keep up the production in China. It prompted companies in US and Canada to identify and drill new, hard to extract crude. Countries like Iraq as well started getting into the endeavour to extract more oil.

A weakening economy and efficiency measures taken for the economy revival adversely affected the demand for oil around Europe, Asia, US resulting in further down grade of oil demand. All these factors finally resulted in a sharp Oil price dip by late 2014.

World was looking at the only saviour - OPEC (Organization of the Petroleum Exporting Countries E.g. Saudi Arabia and Iran) thinking that it would cut off its production to balance out the prices. However, OPEC did not take any such steps as the OPEC states need high prices to balance out their budget.

Oil Prices trend since 1987 - Source: www.vox.com

The reasons for high supply and a low demand are briefly explained in the below Table –

Reason for the High Supply Reason for the Low DemandSupply is up because of U.S. shale oil .High prices prompted companies in the US and Canada in North Dakota's shale formations and Alberta's oil sands ,to drill crude oil

Demand has gone down because of a sustained high prices

Supply is up because of the return of Libya’s production. OPEC did not cut off its production to balance out the prices

Demand for oil in places like Europe, Asia, and the US went on to low, cause of weakening economies and new efficiency measures

Countries like Iraq began producing more oil. There is a growing switch away from oil to other fuel

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3. The Repercussions!!

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“Many exploration and production (E&P) projects, especially unconventional ones, are considered to be unprofitable even at $100 per barrel. These mainly include projects in the North Sea, Mediterranean, Arctic, South Atlantic Deepwater plays and some in the Gulf of Mexico.

It’s blindingly obvious if a project isn’t considered viable at $100, and then it certainly isn’t going to cut it at $60. End result would be mothballing until the market strengthens. Some have used industry doubts about such prospects to cry wolf, with the truth becoming a subject of political football between alarmists and pragmatists.

Robin Allan, chairman of UK’s independent explorers’ association Brindex, says the price decline meant the “North Sea was close to collapse.” While Allan’s assertion that no new North Sea projects would be profitable below $60 stacks up, his fears of a collapse are daft.

What we are about to see is a temporary collapse in confidence with job losses, lower wages and projects delays. For example, take Chevron’s North Sea Rosebank Project. While the company denies a decision has been taken, the project has already been delayed for several years and is likely to face further delays “

Source: http://www.forbes.com

Oil price DIP is boon for many consumers. It would have a negative hit however on the states which primarily depend on Oil sales.

Russia is extremely dependent on oil and gas production. Oil revenues contribute to 45% of the government revenue. Thus, sharp price fall is ruining the country’s economy. Russia’s economy will shrink by 4.5% next year if the current rates for the oil barrel persists. Russia's economy is forecast to fall into recession in 2015 if oil prices do not regain ground quickly enough.

For Iran the story is no different. Incase oil prices do not revive soon, Iranian government has to start thinking for meeting up the revenue from other avenues.

Revenue in Venezuela will shrink by 3% this year as Oil prices continue to dip. Saudi Arabia needs oil prices to be around $85 in the longer term. It with a reserve fund of some $700bn - so can withstand lower prices for some time .Saudi will suffer financially from cheap oil, if the price dips continue for long.

The scenario in USA is just a contrast to the above. Oil Price dip comes as boon for USA as cheaper oil means lower gasoline prices — which have fallen to $2.47 per gallon, the lowest since 2009. This will help consumers to spend their money elsewhere leading to an

With Europe's flagging economies characterized by low inflation and weak growth, any benefits of lower prices would be welcomed by stressed governments.

A 10% fall in oil prices would lead to a 0.1% increase in economic output, say some. In general consumers benefit through lower energy prices, but eventually low oil prices do erode the conditions that brought them about.

China, which is set to become the largest net importer of oil, should gain from falling prices. However, lower oil prices won't fully offset the far wider effects of a slowing economy.

Japan imports nearly all of the oil it uses. But lower prices are a mixed blessing because high energy prices had helped to push inflation higher, which has been a key part of Japanese Prime Minister Shinzo Abe's growth strategy to combat deflation.

India imports 75% of its oil, and analysts say falling oil prices will ease its current account deficit. At the same time, the cost of India's fuel subsidies could fall by $2.5bn this year - but only if oil prices stay low. Source : http://www.bbc.com

References

http://www.vox.com http://www.forbes.com http://www.bbc.com http://www.realclearenergy.org/charticles/2012/10/22/opec_median_budgetary_break-

even_price_106748.html

4. Glossary

1. Shale Oil - Oil shale, also known as kerogen shale, is an organic-rich fine-grained sedimentary rock containing kerogen (a solid mixture of organic chemical compounds ) from which liquid hydrocarbons called shale oil (not to be confused with tight oil — crude oil occurring naturally in shales) can be produced

2. OPEC -Organization of the Petroleum Exporting Countries e.g. Saudi Arabia and Iran

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