The Geopolitical situation in the oil markets are perfectly set up for oversupply, and weak demand is ensuring this oversupply goes nowhere. There is still no bottom forming in the oil markets yet so the troubles look set to remain.
Much of the problems in the oil markets can be pinned on a power struggle going on between OPEC and the US. OPEC, the Organisation of Petroleum Exporting Countries, is a cartel of twelve counties that has controlled the oil markets for decades. Its market share has been undermined by the growth in US oil production, to the point that some are now calling it dead. Certainly, it does not have the market share it once did, currently at 40% and expected to fall to 31% in 2015.
Venezuela, which owns the world's largest reserves, is seeking cooperation between OPEC members to calm prices. This could see a cut in supply to prop prices up. So far, OPEC leaders have been unable to agree on a change in supply.
The other side of the power struggle is the US and its shale oil boom. The US is striving for energy independence and to reduce its reliance on foreign oil imports, so don’t expect it to reduce its output any time soon. However, if prices continue to tumble, we will likely see US producers drop out of the market before OPEC producers, as the US producers operate at a higher cost base.
Further adding to supply pressure is the fact that we have a number of oil producers who need oil revenues to rebuild their economies such as Libya and Russia, currently the world’s largest producer. Of course we have ISIS who now controls a number of northern Iraqi oil fields and want the revenues to build an arsenal.
Saudi Arabia sits atop the second largest oil reserves in the world (behind Venezuela). They have previously said they will not be reducing their oil output until oil hits $20 a barrel.Many believe this is to retain their market share.
$40 seem to be a bit of a magic number and could be the point at which the bulls return to the market. Some of the large wall street banks have reduced their forecasts for oil to this number, which essentially their traders will sell down to. Iran too, is lowering its own budget forecasts for oil to $40 a barrel from $72.
Essentially, what we are seeing from the supply side resembles more of a free market than we have seen in a very long time. But if oil falls too far, we will see some producers dropping out of the market, which will hold up the price.
From the demand side, the growth in renewables has surely played its part to dent demand. We have seen OPEC reduce its demand forecast for oil-based products by 100,000 barrels a day for 2015. With economic trouble in the EU and China’s growth rate slowing, it’s easy to see why. The US is one of the few economies that has a positive outlook, but the oil markets need more than the US. Economic factors would suggest that if the price of oil falls far enough, people will ditch renewables and go back to the black gold, which would support prices.
For the average punter, lower oil prices will likely benefit them, provided they don’t work in the energy sector. Cheaper prices at the pump will likely lubricate the global economy and make that morning coffee a little cheaper. There will be some sectors that will feel the pinch, but many sectors will benefit. The overall outcome for the US economy is likely to be positive.
Oil is in a bear trend for fundamental reasons. A glut of supply and the breakdown of the OPEC cartel means the oil market resembles a free market more now than ever. The global economy will need to get used to a deflated oil price for the foreseeable future.