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Page added on December 19, 2015
An Over-Supply of Underpriced Oil: Explaining the New Energy Crisis
The Organization of Petroleum Exporting Countries (OPEC) recently met in Vienna to discuss an official output quota. By the end of the meeting, however, the member countries did not agree on a quota and oil production remains near record levels. While this may not seem like breaking news, the group’s decision will have major ramifications far beyond its members. That is because this decision comes at a time where the price of oil is falling to lows not seen since the Great Recession. It is also coming at a time when a massive over-supply of oil exists in the market.
Read on to learn more about OPEC’s decision based on its past and future plans. Why does the group refuse to turn off the pumps when the wealth of supply seems to be hurting the bottom line?
History of OPEC
OPEC was founded in 1960 by its five original members: Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. Since then, nine members joined the group: Qatar, Indonesia, Libya, the United Arab Emirates, Algeria, Nigeria, Ecuador, Angola, and Gabon. The organizations’ stated objective is to “co-ordinate and unify petroleum policies among Member Countries, in order to secure fair and stable prices for petroleum producers,” but the group has historically faced criticism for trying to control the price of oil for political and economic reasons. OPEC’s members meet regularly to agree upon oil production quotas, which in turn influence the price of oil internationally.
While many have a negative perception of OPE, the organization’s roots were generally good-intentioned. The group formed shortly after many oil producing countries emerged after colonial empires were split up. Its inception, in part, explains OPEC’s desire to set a price as a means to control and benefit from its member nations’ natural wealth.
Criticism of the group peaked in the 1970s after two high-profile events: namely, its 1973 embargo on oil exports to the United States and the fallout from the 1979 Iranian Revolution. Oil prices eventually dropped dramatically in the 1980s only stabilizing in the 1990s. This happened because of a variety of factors including a burgeoning interest in the environmental impact of oil. Oil experienced another boom in the late 90s through to the mid-2000s. However, it once again experienced a sharp decrease as a result of the 2008 Global Recession.
Image courtesy of the Federal Reserve Bank of St. Louis
Following the recession, oil prices started rising, reaching a peak in 2014. Since the middle of last year, the price of oil has dropped precipitously, causing a flurry of responses from countries that are dependent on the oil industry for survival. The video below provides a detailed history of OPEC:
What is OPEC up to?
The most recent drop in oil prices brings us to where we are now. On December 7, oil prices hit their lowest levels in seven years. In fact, since June 2014 when the price of oil peaked at $108 per barrel, the price of oil has lost two-thirds of its value. The underlying driver behind the recent price drop is primarily an over-supply of oil. One explanation for the drop is the American shale boom, which significantly increased oil production in the United States. Another is the decision by OPEC not to cut its production but to keep it at near record output levels.
If a good’s supply increases but demand stays the same or decreases then its price will go down. The overall goal then is to find the equilibrium somewhere in the middle, where sellers can offer their goods at a price they feel is reasonable and at which consumers are willing to pay. OPEC’s recent decision to continue to keep production levels high has contributed to the massive drop in the global price of oil. Doing so challenges OPEC members’ ability to cover their expenses and profit off of high prices.
The question then is why? The simple answer is market share and scale of production. Saudi Arabia, a major player in OPEC, is willing to take a loss on oil in the short-term in an effort to disadvantage its competitors. The relatively long period of high oil prices that occurred over the past few years made new, more expensive means of getting oil profitable. This led to a rise in oil extraction methods like deep-water drilling and shale oil production (including fracking) in the United States. This method of getting oil is notably difficult and expensive, but with high oil prices, companies were able to spend more to extract oil because they could still turn a profit. Now that the price of oil has fallen dramatically, such efforts are becoming too expensive and shale oil production has gone down. If the price of oil stays low for a long period of time this could significantly hurt the shale industry helping OPEC countries like Saudi Arabia in the long run. This would play into the Saudis’ long-term goal of gaining back its market share, once the playing field has been thinned. But while a decrease in U.S. production has already started to happen oil prices have not yet gone back up, putting oil producers in a tricky place. The accompanying video gives a look at OPEC’s actions:
In the meantime, Saudi Arabia and the rest of OPEC also have to contend with other established nations in the oil industry, namely Russia. While the Saudis have started to make their way into traditional Russian oil markets, Russia has fired back by temporarily becoming the largest supplier to Asia, an area typically dominated by OPEC. The struggle between these two has also added to the oversupply in the market, as neither wants to concede its customers.
Further Trouble Ahead
OPEC’s strategy is decidedly risky for reasons beyond temporary loss in revenue due to lower prices. First, there’s the return of Iran to the forefront of the global oil market. Iran is currently under sanctions and its oil exports are limited to roughly 1.1 million barrels a day–about half of its peak production in 2012. However, international sanctions on Iran are now going away in light of the Iran nuclear deal, and the country plans to produce 500,000 more barrels a day with the ultimate goal of reclaiming its market share–as Saudi Arabia and Russia are doing–no matter the cost.
Second, demand for oil could also start contracting next year, as some analysts think demand could shrink by up to as much as one-third. While drivers typically do more driving when oil is cheaper, the economic slowdown in Asia, particularly in China, threatens to cause an even larger over-supply of oil on the world market. But foreseeing changes in demand can be particularly difficult. Other analysts argue that the recent changes in China could lead to even greater demand for oil as the country shifts to a more consumer-driven economy.
Ramifications
OPEC
The concerns listed are less true for Saudi Arabia, OPEC’s de facto leader, which the IMF estimates can last about five years with oil prices at current levels before it needs to make significant changes to its budget. The Middle Eastern countries in the worst shape, however, are Iran and Iraq. While Iran’s refining costs are not particularly high relative to other countries, its economy suffered a significant blow from international sanctions. Its neighbor, Iraq, is in even worse shape, facing not only mounting debt but also the specter of ISIS operating and controlling a large swath of its territory. Forgone revenue from unusually low prices could start to hurt oil-exporting countries without large cash reserves.
The consequences of low oil prices could be just as bad, if not worse, for members of OPEC outside of the Middle East. Countries such as Ecuador, Venezuela, Nigeria, and Algeria are extremely reliant on oil for government revenue, often for the majority of their budgets. Low prices have already sparked fear of unrest in areas such as Nigeria and Venezuela, who like Saudi Arabia use oil revenue to maintain social and economic stability. In Ecuador, these fears have already been realized–thousands have gone to the streets to protest government cost-cutting as a result of the falling price.
Russia
Outside of OPEC, perhaps no country is feeling the effects of the declining value of oil as much as Russia. Like many of the OPEC nations, it is very dependent on oil for income. In fact, oil and gas make up roughly two-thirds of Russian exports and half of all government revenue. With prices dropping so low, the nation has subsequently felt the effects–Russia’s economy will contract by about 3.8 percent this year and is expected to shrink further in 2016.
United States
Unlike Russia and the OPEC nations, the United States is not particularly dependent on oil production for government revenue, but the drop in prices will have some impact. If OPEC and Saudi Arabia hope to keep prices low to eliminate American competitors, evidence suggests that may be working. The number of oil rigs in the United States has fallen slightly and domestic production has decreased. In fact, for some U.S. states that rely on the oil industry for jobs and revenue, like Texas, Alaska, North Dakota, Oklahoma, and Louisiana, falling prices can pose a notable economic challenge.
However, the price plunge is certainly not all bad news for Americans. The average price of gasoline per gallon is now considerably lower than this time last year. Additionally, according to the United States Energy Information Administration, the average household is also likely to save $750 on gas this year. These savings are especially helpful for lower-income people who spend more of their income on gas and heating. Similar savings will likely occur in many European countries as well. The following video looks at some of the effects of low oil prices:
Conclusion
The members of OPEC, particularly Saudi Arabia, are taking a notable gamble with their decision to keep oil production high despite low prices. If oil-exporters reduce their production they could lose their market share, but if oil prices remain low they could face fiscal crises and possibly unrest. Yet the decision could pay off in the long run as more expensive forms of oil production slow down and prices go back up.
While OPEC is notably pumping too much oil, an issue that will likely become worse when Iran increases its exports, nearly all oil producing countries find themselves in a race to the bottom. Oil producing countries are already experiencing the consequences of low prices, but that will likely worsen if the status-quo continues. Meanwhile, the United States and most oil-importing Western nations stand to benefit.
31 Comments on "An Over-Supply of Underpriced Oil: Explaining the New Energy Crisis"
BobInget on Sat, 19th Dec 2015 1:18 pm
An unidentified male dead body was discovered roadside near the parkway.
Cause of death, two gunshot wounds. One in the chest another in the head.
Like the hacked out piece above, no Motive for death or oil’s overproduction reported.
We ‘learned’ the obvious. A dead guy and
there’s too much oil in the market at a time of growing consumption, world-wide.
Nine million people are running away from the biggest oil war in modern history.
Not a single mention.
Saudi Arabia spending (so far) thirty billions+
to control Syrian and Yemeni oil and pipe-lanes. Not a peep.
have a peek…
http://www.investorvillage.com/groups.asp?mb=19176&mn=729&pt=msg&mid=15579505
Brian Richards on Sat, 19th Dec 2015 2:51 pm
I had a couple of random thoughts about the Saudi Arabian “retaining market share” meme. What if Saudi Arabia’s sovereign wealth fund advisers have recommended that oil be sold at any price because renewables and associated technologies are advancing rapidly and there will be only a few specialized industries needing oil in 20 years or so? note: I don’t have a clue. Or the SA SWF advisers read “shortonoil” postings, and agree with him 🙂 ? If Saudi Arabia was convinced that oil will retain its’ value, then why not leave in in the ground, reduce the amount they pump by a few million barrels per day or whatever it takes to raise the price? Or is “market share” the most plausible answer?
rockman on Sat, 19th Dec 2015 3:54 pm
“That is because this decision comes at a time where the price of oil is falling to lows not seen since the Great Recession.” So, according to their chart the, “Great recession” ran 25 years from 1980 to 2005.
“It is also coming at a time when a massive over-supply of oil exists in the market.” Yet they also point out the world is consuming more oil the ever before. Difficult to follow that logic: wouldn’t a “massive over-supply be marked by companies cutting back production because there weren’t enough buyers to purchase their oil. Like when there a “massive over-supply” of Christmas trees and the lots are full of them just sitting dropping more of their needles. as the days pass. By their logic if there were a :massive over-supply of trees we would see empty sales lots.
“OPEC’s strategy is decidedly risky for reasons beyond temporary loss in revenue due to lower prices.” Again difficult to follow that logic: OPEC and the KSA have increased production to max their revenue: if they sold 1 million bopd they would lose the better part of $10 BILLION per year even if that did bring up prices a bit. And there’s no guarantee of that happening since a price increase might reduce total sales volume.
Which is exactly the big component of their utter bullsh*t “over supply” assumption they keep making but never explicitly state: the world would keep buying record amounts of oil if it only would cost, hmm, lets say $30/bbl more. Yeah…just what the world is hoping for: chance to transfer an extra $1 TRILLION per year to the oil producers. That world certainly pull the global economies out of their current doldrums. lol
JuanP on Sat, 19th Dec 2015 3:54 pm
What a load of propaganda and BS this article is.
“Second, demand for oil could also start contracting next year, as some analysts think demand could shrink by up to as much as one-third.” I am sick and tired of “experts” that can’t tell the difference between demand and demand growth.
“The number of oil rigs in the United States has fallen slightly and domestic production has decreased.” Slightly? Really? Experts, please correct me if I am wrong, but I believe around two thirds of oil rigs have been idled in the last year and few months from somewhere around 1,500 to around 500. That is not a slight fall, it is an extremely drastic fall, IMO.
I won’t even go into the whole OPEC did this thing or that thing again. The USA’s QE and ZIRP artificially raised oil prices and lowered loan costs creating the shale oil and deep offshore bubbles, OPEC had nothing to do with it. This problem was created in the USA and will be solved as American shale oil production falls in the coming years.
onlooker on Sat, 19th Dec 2015 3:59 pm
“That world certainly pull the global economies out of their current doldrums. lol” Exactly, if oil this cheap has not stimulated the world economy how would more expensive oil? It will not.
BobInget on Sat, 19th Dec 2015 4:39 pm
Almost everyone is pumping flat out hoping against hope to produce enough to pay royalties and loans.
Over pumping, deferred maintenance, prescriptions for trouble down the road.
I fear only messy Canadian oil sands will be left standing.
The bright side ? We pivot to natural gas.
Plantagenet on Sat, 19th Dec 2015 4:40 pm
There is no such thing as “underpriced oil” on the world market. The price is set by supply and demand. Today’s price is low because we are in an oil glut.
Cheers!
Boat on Sat, 19th Dec 2015 4:50 pm
Given time cheap oil will certainly cause growth that would not have happened at high prices. Why? People who normally pay a high price for energy will have more cash laying around to spend on other stuff. People who claim low oil prices haven/t made an impact are wrong, it just takes time for the full impact show in the numbers. If in America for example every family saved $900 per year they could buy a 60″ TV once a year. Lol
Truth Has A Liberal Bias on Sat, 19th Dec 2015 5:34 pm
While KSA has increased its market share by about 5% which is roughly worth about 35 billion USD they have also lost about 140 billion USD in revenue due to low prices. Seems like a poor policy if one wishes to profit in the near term. Which leads me to believe they wish to reap some long term reward. In my arrogant opinion it is a poor policy as in the long term the price will rise as demand increases and supply contracts. And at that point LTO and renewables will resume competitiveness. The new king of KSA and his advisors are not too bright. They are however rich and once KSA crumbles they’ll flee to the south of France with the movables and leave the rest of the nation to its fate. Most countries produce policy based on national interests. The rulers of KSA will squeeze the place for everything it’s worth then di di mau outta there.
peakyeast on Sat, 19th Dec 2015 7:12 pm
@Bob: I get this message from your link:This is a Private group.
makati1 on Sat, 19th Dec 2015 8:40 pm
The state of the world economy is a four letter word: D E B T.
THAT fact is constraining any real growth overall. Past consumers of high priced oil are not only broke, but in debt up to their limits or more. Ditto for their countries governments who have to print or die. Growth is over. Contraction is the new “IN”. Adjust.
GregT on Sat, 19th Dec 2015 8:47 pm
‘If in America for example every family saved $900 per year they could buy a 60″ TV once a year.”
Wow Boat, in your example that would work out to $2.46 per day, per family. So a family of four, for example, could share a Big Mac every second day with a windfall like that.
Now if one were to take the average miles driven per vehicle in the US, or 11,000 miles:
http://www.afdc.energy.gov/data/
And divided that by the average milage, or 25.5 MPG:
http://www.autonews.com/article/20150604/OEM05/150609925/average-u.s.-mpg-edges-up-to-25.5-in-may
One would come up with the average amount of fuel consumed per vehicle per year. Which works out to be 430 gallons per year. So yes, a family of four with two average vehicles, driving the average amount of miles per year, could possibly save ~$900 per year compared to one year ago. But compared to 12 years ago, that family is actually paying ~20% more for fuel, and their average wages are actually less when inflation is taken into consideration.
GregT on Sat, 19th Dec 2015 9:04 pm
And in addition Boat,
I’m sure that most families concerned with saving an extra $2.46 per day, probably don’t own 2 vehicles. In that case the average “savings” would be closer to $400 per year, or $1.23 per day. Enough for less than two Big Macs a week.
Boat on Sat, 19th Dec 2015 10:19 pm
GregT,
My family has 4 vehicles. We average over 120 miles to and from work on an average day. Life in a big city if you have multiple jobs. $3.80 was the high per gallon a couple years ago, now $1.65. A little more than a couple big Mac’s. We average 25 mpg but think of all the poor driving old pickups pulling a trailer that are lucky to get 10 mpg. In Houston there is a massive construction and landscape business. They don’t get paid much and have to travel a lot. The savings are significent. Houston isn’t a normal city, it is spread way out with hundreds of subdivisions.
Apneaman on Sat, 19th Dec 2015 11:27 pm
Boat, Atlanta is spread way out with hundreds of subdivisions. Calgary is spread way out with hundreds of subdivisions, plus it snows a lot. Vancouver is spread way out with hundreds of subdivisions plus it rains all the time. I have lived and commuted in all 3. Atlanta was the worst IMO, but it did not even make the top 20. Maybe because they all drive so fucking fast there – holy shit. Houston came in at 20. Pussy.
http://www.dailymail.co.uk/news/article-2650455/Revealed-The-cities-worst-traffic-North-America-MORE-clogged-year.html
GregT on Sat, 19th Dec 2015 11:30 pm
“My family has 4 vehicles.”
Most families (Did you not say that you were living with roommates?) do not have 4 vehicles Boat, unless the adult children cannot afford to move out on their own.
GregT on Sat, 19th Dec 2015 11:42 pm
Canadians need to be better at something Apnea. Where’s your pride man?
http://www.vancouversun.com/Vancouver+edges+Angeles+worst+traffic+congestion+North+America+index/9132912/story.html?__lsa=cb07-eb67
Apneaman on Sat, 19th Dec 2015 11:49 pm
4 vehicles boat? It’s good to have choices.
Mobile homes: Many ‘hidden homeless’ Americans living in vehicles
http://america.aljazeera.com/watch/shows/america-tonight/articles/2014/10/10/mobile-homes-manyhiddenhomelessamericanslivinginvehicles.html
The 1% wants to ban sleeping in cars – because it hurts their ‘quality of life’
“Their hope, of course, is that homeless people will go elsewhere, despite the fact that the great majority of homeless people are trying to survive in the same communities in which they were last housed – and where they still maintain connections. Americans sleeping in their own cars literally have nowhere to go.”
http://www.theguardian.com/commentisfree/2014/apr/15/ban-sleeping-in-cars-homeless-silicon-valley
Number of homeless living in cars, RVs in LA grows
http://www.scpr.org/news/2015/07/23/53164/homeless-living-in-cars-baffle-neighborhoods/
Apneaman on Sat, 19th Dec 2015 11:52 pm
WERE # 1!! WERE # 1!! WERE # 1!! WERE # 1!! VAN! VAN! VAN! VAN! FUCK YEAH!!
Apneaman on Sat, 19th Dec 2015 11:53 pm
WE’RE
Apneaman on Sat, 19th Dec 2015 11:54 pm
Here in my car…
https://www.youtube.com/watch?v=Ldyx3KHOFXw
Apneaman on Sun, 20th Dec 2015 12:00 am
I love sleeping on warm leatherette.
https://www.youtube.com/watch?v=S5QErPDNcj4
GregT on Sun, 20th Dec 2015 12:15 am
“WERE # 1!! WERE # 1!! WERE # 1!! WERE # 1!! VAN! VAN! VAN! VAN! FUCK YEAH!!
That’s the spirit.
onlooker on Sun, 20th Dec 2015 1:48 am
Careful you guys are talking like Americans who always like to say WE’RE # 1. HAHA.
Boat on Sun, 20th Dec 2015 8:22 am
onlooker,
Why would you like to celebrate the misfortune of anybody in any country. You doomers are a weird lot.
onlooker on Sun, 20th Dec 2015 9:26 am
Whose celebrating any misfortune. Not me. I am saying that we here in the US in fact are No. 1 in some areas maybe we would not wish to be. Like obesity, drug use, firearms, etc etc. Also, that we do have a superiority complex and it is time we show some humility as it would endear us more to the rest of the world. So I think I am in fact trying to show what we are not No. 1 in terms of countries without social ills. Because I do care about the downtrodden and the those with misfortune
adonis on Sun, 20th Dec 2015 10:28 am
my guess is ksa is under instructions from usa to do this what were dealing here with is deception on a grand scale they need the world to believe that ksa aka opec caused the next ‘coming’ economic collapse when the shale plays go under and GFC part 2 begins.the shale plays were gonna go bust whatever opec does the geology just aint there
GregT on Sun, 20th Dec 2015 11:44 am
My guess would be along the same lines adonis. Not the USA per se, but rather the CBs. They have the world by the balls, and the USD is their main tool of control.
adonis on Sun, 20th Dec 2015 12:32 pm
absolutely Greg the CBs are directing things here not the Usa sorry to tred on any toes out there
onlooker on Sun, 20th Dec 2015 1:20 pm
It is just more of trying to keep the “Big” deception going. That unconventional is a medium-long term loser and that the world is fine with this glut of oil and just wait till prices are higher we will have that much touted economic revival. Because logic is null and relatively low price oil not spurring economic vitality is well “just ignore that” haha.
rockman on Mon, 21st Dec 2015 10:51 am
Truth – “While KSA has increased its market share by about 5% which is roughly worth about 35 billion USD they have also lost about 140 billion USD in revenue due to low prices.” Very good point. But folks should understand that the KSA didn’t take 5% of the market from anyone. The market just expanded as the lower prices increased the number of potential buyers.
The buyers/refineries refused to continue paying for high priced oil. In order to max their revenue the KSA has increased the depletion rate of their finite reserve base while receiving less revenue in the process. The KSA has not taken one bbl of market share from any US shale producer: the shale players are currently selling every bbl they can produce. What those companies aren’t doing is drilling as much as they had been. But they are still producing all the oil they can…just as OPEC (probably including the KSA) is doing. It makes a little sense to say US shale producers won’t cut back production in order to take away market share from the KSA as to say that’s the motivation behind the KSA production increase.
It still amazes me that anyone thinks this dynamic was intentionally created by the KSA/OPEC: selling their finite inventory at a big discount is a smart business plan? lol.
Again just to make sure everyone caught this important point: while so many have argued that the KSA increased production to take market share away from US shale producers: the US shale producers haven’t lost 1 bbl of market share. The market share that the KSA is selling into is all the new buyers that can now afford the lower oil price.