The price of crude oil has been falling in recent years, going from over $100 per barrel in 2014 to hovering around $50 per barrel in 2017. In light of declining oil prices, the Organization of the Petroleum Exporting Countries (OPEC) has spent much of 2017 taking steps to stimulate a rebound in crude oil prices. However, there are a myriad of issues across OPEC and non-OPEC nations that have prevented the cartel’s mandated supply cuts from achieving their expected level of success.
The US Energy Information Administration (EIA) and OPEC expect oil prices to rebound in 2017 after three years of declines, but there are reasons that suggest this effect will not be as profound as OPEC expects. In fact, it may not happen at all. IBISWorld has highlighted the impact of uncertain crude oil prices on various markets.
Oil Cuts Miss the Mark
In 2016, OPEC began spearheading a proposed cut of 1.8 million barrels of oil per day. Non-OPEC nations, on average, have never met more than 80 percent of a proposed cut in any given month since they do not have the same financial incentive that OPEC nations do. Falling oil prices have provided opportunities for these countries to grow their burgeoning energy industries.
However, OPEC has not received the anticipated level of compliance from its own nations either. In June and July of 2017, for example, OPEC countries only met an average of 85 percent of the targeted cuts. In fact, Saudi Arabia, the UAE and Iraq, which are the three largest oil producers in OPEC, are averaging only 80 percent of their targeted cuts. Venezuela is one of the few leading oil producers that have been greatly reducing their oil production. However, this is largely due to severe economic distress in the country preventing the state-run oil company from continuing to produce at their normal levels.
While these cuts were supposed to end in mid-2017, OPEC has opted to extend the cuts in production by nine months, until March 2018.
While OPEC has been struggling to adapt to current oil price trends, US shale oil production have been booming. Due to significant US shale feedstock, particularly in places like the Permian Basin in Texas, US shale drillers have had lower-cost access to key natural resources. US shale drillers are better equipped to deal with low prices due to the prevalence of new, more efficient fracking processes despite also being subject to the low price of crude oil. Reduced operating costs from more efficient shale drilling methods and a greater demand for US oil exports in the wake of low prices have contributed to a major boom in US energy markets. As such, profit margins for US providers of oil and gas drilling services,like hydraulic fracturing services, as well as oil and gas well maintenance services,have grown despite falling service prices.
Although service prices are falling, buyers only benefit so much because heightened demand moderates the rate of price declines. IBISWorld advises buyers to purchase services now and to attempt to sign long-term contracts. Buyers should also negotiate clauses dictating maximum price increases throughout the length of the contract.
Suppliers in these markets have also opted to heavily expand their labor force to meet growing demand for US oil exports, as shown by the addition of more than 10,000 oil support jobs in March and April of 2017. To meet the skyrocketing demand for ancillary oil and gas services, operators in this sector have been investing more in research and development (R&D) for shale drilling process improvements. Techniques such as refracking have allowed producers to extract a larger amount of shale oil at a lower cost.
One performance indicator to track is the Brent-WTI spread, which measures the difference in price of two separate oil indices: the European Brent Index and the US-based West Texas Intermediate. Traditionally, these indices have traded on par with one another, but larger discrepancies in supply between various oil producers cause oil trading prices to exhibit greater variability. Since OPEC announced their plan to stifle oil production, the Brent-WTI spread has increased over 20 percent, indicating significantly higher prices from European oil producers compared to their U.S counterparts.
Unfortunately for OPEC, the EIA forecasts US shale output to continue growing for much of the upcoming year, as it has for nine of the past 10 months. Process improvements in the Anadarko region in Oklahoma and Texas, particularly in drilling efficiency and completion technology, will drive higher output. A higher domestic shale output will continue to place downward pressure on oil prices.
Impact on Downstream Markets
Falling global oil prices have also contributed to price declines for some downstream markets. This effect is particularly pronounced among products and services that use gasoline and crude oil inputs, such as domestic air cargo transportation and national trucking services, as well as commoditized plastic products. These products and services are heavily influenced by volatility in oil prices. For example, since 2014, the price of plastic bottles has been falling at an estimated annualized rate of 4.9 percent. Various related products, such as plastic film,plastic bags and plastic shipping crates,have also been falling in price over the past three years. Buyers of these products have been benefiting from various economic factors that have reduced plastic prices and demand.
If OPEC’s future production cuts still fail to raise oil prices, current trends in price and demand for plastic will continue. As such, buyers should look to take advantage of lower prices of these downstream markets while they still can.
On the other hand, declining oil prices have been tempering the price of transportation services by lowering suppliers’ input costs. In conjunction with increased oil production, declining oil prices have encouraged the transport of greater quantities of oil as both crude oil exports and finished oil products. Therefore, as OPEC continues to struggle with the price of oil, US oil producers will continue to expand their use of midstream oil and gas services.
As the leading group of oil producing nations, OPEC has reason to worry that declines in oil prices may persist well beyond 2018. US shale continues to be strong in supply and is not expected to wane. US shale producers, along with businesses throughout their supply chain, continue to enjoy competitive advantages through innovations in their production process and lower-cost access to resources. The abundance of supply is so strong, OPEC’s best bet is to hope demand continues to grow and compliance levels for output restrictions improve across the board.
Roshan Sathyanarayana is world procurement research analyst at IBIS.