Published: October 9, 2015
Unless you have been under a rock for the past year, you might have noticed that oil prices have been consistently dropping. Analysts have been polarized for months on whether the low prices will persist, continue falling or climb back up. Many were saying that oil prices cannot stay low for long, as consumers witnessed unceasingly tumbling prices. Buyers have been grateful for the respite from the high oil prices they had seen in previous years.
“It doesn’t break the bank to go places anymore. Now I’m much more likely to drive home for the weekend, since gas isn’t as expensive as it has been in previous years,” said senior psychology major Christi Riley. Consumers have observed more than a 50 percent drop in the price of oil in the past year, adding to their disposable income. To the appreciation of most consumers, oil prices may proceed to fall as the world’s top oil producers, Saudi Arabia, Russia and the United States, continue to engage in a game of chicken, waiting for their rivals to blink and cut production.
Russia and Saudi Arabia stated that they will not be cutting production from the sizable output levels that helped drive prices down. Russia has been pumping an average of 10.74 million barrels a day, the highest level it has seen since the fall of the Soviet Union. Saudi Arabia has also intensified production in the past few months, surpassing 10 million barrels a day. United States’ production has dipped slightly in recent months to 9.3 million barrels a day, which is still significantly higher than a year ago, when prices were more than double. The global oil market is already oversupplied, and the huge output from those three countries is not helping the situation. On any given day, supply exceeds demand by approximately two million barrels.
The global oil price benchmark, Brent crude, is currently trading at about $48 a barrel, whereas prices were more than $110 a barrel just a year ago. One explanation for the increased output and falling prices may be that producers need the cash. The lower the price, the more the producers need to sell in order to maintain its revenue.
“Saudi Arabia has to make money by selling oil, because their whole economy demands on it. It’s 90 percent of their revenue. They have to maintain their budget and since their reserves are high, supply is high and production costs are low, they’ll just keep producing oil in substantial amounts,” said Riaz Hussain, Ph.D., a University finance professor.
Organization of the Petroleum Exporting countries decided to defend its market share last year by maintaining high output after the U.S. increased its oil output. They have made it clear that it would only consider cuts if non-OPEC members, such as Russia, would also bear the burden of slowing down production, but Russia has shown no signs of joining a coordinated production cut. Russia has denied any possibilities of production cuts unless oil prices remain low for a long period of time, and even then the cuts would not be substantial.
”Even if Russia lowers its production, that cannot stop the fall in world oil price, but in the process Russia’s GDP will be adversely affected. This may be true for Saudi Arabia also. (In the past when they lowered their price their GDP was adversely affected). But there is another reason that may be motivating Saudi Arabia not to cut back production.
Saudi Arabia is a low-cost oil producer. They can withstand further reduction in oil prices but can still remain profitable (although their GDP will suffer). But the continued fall in oil price in the long run can undermine U.S. shale oil production which has a much higher cost of production. As Saudi Arabia lets the price of oil drop further, it may secure greater control of the global oil market in the long run,” said Satyajit Ghosh, Ph.D., an economics professor at The University.
Bloomberg News found that at least 15 percent of first quarter revenue for a majority of oil and gas companies in the Bloomberg Intelligence North America Exploration and Production Index came from hedges that enabled U.S. producers to set prices. As a result, their output earns more than market price. The hedges are a large part of how U.S. producers have been able to maintain high production levels, but most of them will dry up by the end of the year. By then, their combined debt of $235 billion will be tough to pay back.
The United States had become a huge player in the global oil markets in recent years, as it began to drill more and become less dependent on imports. In the price war between the major oil producers, the U.S. has shown some weakness by slightly cutting production in past months and may be the first to knuckle under the pressure.
“Saudi Arabia and Russia are trying to run U.S. oil companies out of business, and they can because they have so much more capital than U.S. companies. They’re trying to regain their strongholds in the industry,” said Jordan Den Herder, a junior finance major.
Natalie Bai, junior Biology major said, “Russia is in the middle of a very patriotic time and they’re continuing to produce oil in order to hurt a vital part of our economy.”
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