Business and Economic Update
Issue 03

Opportunities of Low Oil Prices

Just when many people have thought that the $52-$55 a barrel crude oil prices experienced in March to April this year was already the bottom because prices have slowly recovered after that, another round of oil price declines occurred this month.

West Texas Intermediate (WTI) prices lately were trading at $38-$40 a barrel. These are lower than the levels reached during the sub-prime and housing prices turmoil in the US that spread to the rest of the world in 2008-2009. And these are prices that were seen in 2004 and earlier years.


Obviously this is good news for many people and business sectors. Cheap oil means cheaper cost of production for many industries and businesses. What are the reasons for this new phenomenon?

One, huge and excess supply of oil. , the world currently has excess crude oil supply of 2-3 million barrels per day (mbpd), daily looking for more storage spaces.

The US Energy Information Administration (EIA) observed that
"Global liquids production continues to outpace consumption, leading to strong inventory builds throughout the forecast period. Global oil inventory builds in the second quarter of 2015 averaged 2.7 million b/d, rising by 0.8 million b/d compared with the first quarter of the year. The pace of inventory builds is expected to slow in the second half of the year, to roughly 1.8 million b/d. In 2016, inventory builds are expected to slow to an average of 0.9 million b/d.”

Member countries of the Organization of Petroleum Exporting Countries (OPEC) are projected to retain their daily output of nearly 31 mbpd this year and next year, while output by non-OPEC countries is projected to rise to more than 58 mbpd.

Table 1. World petroleum supply and demand, 2013-2016, in million barrels per day (mbpd)

Source: US EIA, Short-term energy outlook, August 11, 2015.

OPEC has a slightly different data than the above numbers. In its monthly report for August 2015, OPEC numbers show that the balance between global supply minus global demand rose from a deficit of 0.2 mbpd in 2013 to a surplus of 1.1 mbpd last year, to a huge 2.9 mbpd in July this year.

Oil demand by developed countries of the Organization for Economic Cooperation and Development (OECD) is declining, from an average of 46 mbpd in 2012-2014 to only 45.4 mbpd in the second quarter of this year. This is a reflection of their weak and anemic growth, exacerbated by the recent public debt crisis in Greece.

World oil supply is rising fast. From a deficit in 2013 to a 1.1 mbpd surplus in 2014, up to almost 3 mbpd in the second quarter this year. Faster growth of supply relative to demand means the price must go down. The bigger the surplus, the bigger will be the price decline.

Table 2. World oil supply and demand, 2012-2015, mbpd

Source: OPEC, Monthly Oil Market Report, August 2015

Two, continued high output of US shale oil. While fracking to get shale oil and gas has been around for nearly two decades ago, it was in the last three years that significant oil output by the US has been experienced.

Chart 2. US oil production, 1960-2015.

Three, OPEC members are fighting to retain their market share. They did not cut back production as they used to do to arrest declining oil prices.

Saudi Arabia for instance used to produce 9+ mbpd but this year, it expanded this to 10+ mbpd as it struggles to keep its market share, or dueling with oil producers from the US and Russia.

Iran is also returning as a major oil producer. Its production levels in 2011 before the sanctions were at 4 mbpd. During the sanctions, it was producing some 2.7 mbpd, and can easily reach the old 4 mbpd next year.

Table 3. OPEC crude oil production (based on secondary sources), mbpd, and number of oil rigs (total may not add up to due rounding off)

Source: OPEC, Monthly Oil Market Report, August 2015.

Notice the productivity per rig. Only Iraq, Nigeria, Angola, Ecuador and Libya have experienced significant productivity increase. The rest have little or none.

Chinese oil production through fracking has risen to the same extent as USA production.

Four, non-OPEC supply has shown consistent increases. The US is leading this, followed by Canada. Russia remains the second largest oil producer in the world but it is struggling whether to raise production to raise revenues despite declining prices, or retain its output and wait for price recovery in the coming months and years.

Table 4. Non-OPEC oil supply, 2012-2015, in mbpd

Source: OPEC.

India remains a small oil producer and four ASEAN countries retain their average annual oil output. Indonesia has left OPEC several years ago.

Five, rising productivity of oil rigs by non-OPEC producers. Earlier estimates placed the break-even point of a fracking rig at $60 to $70 per barrel. This was proven to be wrong. Advances in technology and the agility of fracking producers resulted in higher output from fewer rigs.

Table 5. Non-OPEC rig count, 2011-2015

Source: OPEC.

A recent Bloomberg analysis showed that in North Dakota's McKenzie County, part of the Bakken shale play, the break-even price is about $29. Which means that even if oil prices remain at $38-$40 a barrel, producers can still make marginal profits.

Continuous innovation and development in drilling technology using big data and robotics have significantly reduced the cost and time of drilling and finding oil. From a Forbes report last August 23, 2015, an article said that “Faster drilling means cheaper drilling, which makes marginal oilfields economical at lower oil prices. It costs about $20,000 a day to contract an onshore drilling rig, so shaving four days off a well yields an immediate $80,000 in savings. If smarter computers can reduce a rig’s head count by one, cut another $200,000 a year in salary, benefits and accommodations."

Six, anemic growth in the OECD countries and now, low pace of manufacturing and exports growth in China.

Vehicles, planes and boats have become more fuel efficient too, their distances covered per liter of gasoline or diesel have increased. The same higher fuel efficiency is also experienced by oil-based power plants.

From the above numbers and discussions, low oil prices will be with us in the short to medium term. Developing countries like the Philippines should seize this opportunity to further expand and optimize economic growth.

Consider the low total primary energy supply (TPES), expressed in tons of oil equivalent (toe), and low electricity consumption of developing South East Asian economies. High TPES means higher energy input for agriculture, industry and services sectors.

Table 6. Selected energy indicators for 2012.

Source: International Energy Agency, Key World Energy Statistics 2014.

Thus, among the opportunities of low oil prices are the following.

  1. Oil-based power plants that are used only for peak hours because of its relatively expensive fuel compared to coal, natural gas and hydro, can be made to run more frequently without generating higher electricity prices for the consumers and the public.
  2. The cost of air, land and sea transportation should decline significantly and hence, more people and goods can be transported at lower costs. Minus the effects of currency depreciation, tourism and related sectors (airlines, hotels, restaurants and other shops) should benefit from cheap oil.
  3. Agriculture and fishery sectors can benefit as more farmers and fisher folks can afford to use more hand tractors and motorized boats in their work. There should be corresponding productivity and income increases for these rural and fishing-dependent sectors of the labor force.
It should be mentioned that governments should resist temptations to raise oil and energy taxes because this will negate or cancel out the gains from low oil prices.

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