Oil Rig

What will oil prices do in 2015, and what will it mean on May 7th?

By: David Bailey @dgbailey
Published: Friday, January 9, 2015 - 09:59 GMT Jump to Comments

Falling oil prices could destabilise some countries. But in the past conflict and instability has led to rising oil prices! The only certainty is uncertainty. How will uncertainty over oil effect the UK economy?

After five years of stable oil prices, the oil price has fallen by more than 50% since June 2014, when it was trading at around $115 a barrel. It is now trading at less than $55 a barrel. This week, US oil prices briefly fell below $50 a barrel for the first time since April 2009, and Brent crude, a global price benchmark, fell below the $55-a-barrel mark.

As any economist will tell you, the oil price is determined in part by actual supply and demand, and in part by expectations. Most recently, in late November, a meeting of the Organisation of Petroleum Exporting Countries (OPEC) – a cartel which covers 40% of world supply, failed to reach an agreement on production limits. That sent the oil price tumbling on international markets.

Back in the global recession in 2009, US and Brent oil prices dropped under $40 a barrel as demand fell back. This price fall is somewhat different in that both supply and demand are having an impact.

On the demand side, price falls in part reflects an economic slowdown in China, recession in Japan and looming deflation in the Eurozone. Few analysts expect growth to pick up in Europe, China or Japan anytime soon. So global demand is expected to remain weak in the near future.

More broadly, demand has softened not only because of weak economic activity, but also due to increased efficiency in how we use oil, and a switch to other fuels away from oil.

In contrast, between 2010 and 2014, oil consumption was increasing, while global oil production struggled to keep up. As a result, stockpiles were reduced, and prices rose to over $100 per barrel. That in turn incentivised shale oil drillers in the US, in places like Texas and North Dakota, reducing US demand for imported oil.  The US shale boom, though, was in part offset by supply disruption owing to conflicts in oil producing nations like Libya and Iraq.

Since mid-2014, however, things have shifted, with recent price falls driven by unexpected supply growth. Oil output is at a high.

Prices fell heavily last week on reports that Russian oil output hit post-Soviet Union records and Iraqi oil exports were also at their highest since the 1980s (despite conflict there).

Remarkably, the US recently became the world’s largest oil producer. By the end of 2014, the US was producing over 9m barrels of oil per day, up 80% from 2007. Though it has not exported crude oil, it now imports much less, creating a lot of spare supply in global markets. In addition, the US is just starting to ease restrictions on oil exports, and this could be a major factor in future markets.

A number of US producers have recently responded to low prices by cutting 2015 investment, but it will likely take months for supply growth to slow enough to reduce the global over-supply of oil, and overall US oil production is set to rise again in 2015.

Thirdly, and linked to that OPEC decision in November, Saudi Arabia and its Gulf allies have decided not to sacrifice their own market share to restore the price. They could cut production dramatically, but the benefits of this would flow in large part to countries such as Iran and Russia, so they have held off doing so.

The Saudis are thought to be able to tolerate lower oil prices quite easily, as its oil costs very little to produce (just $5-6 per barrel). It also has around $900 billion in reserves.

For oil consuming nations including the UK (we’re no longer a major oil producer), lower oil prices will provide a boost to economic growth. In the UK, the annual inflation rate as measured by the consumer prices index is likely to fall as low as 0.5% in the first few months of 2015 as oil prices fall.

Consumers will spend less driving cars and heating homes, leaving more left over for consumer spending. That’s a big plus for the government in the run up to the election. A knock on effect is that low inflation will mean that the Bank of England will hold off raising interest rates until after the election. Mortgage rates will stay low.

What will oil prices do in 2015? At the moment high-cost oil producers and oil-producing regions are losing money. As a result, over the medium and long-term, companies will be forced out of the market, precipitating an oil price rise. So the question then is: by how much, and when?

A number of variables will influence the answer to that question, such as:

US production.  As noted above, US investment on oil production is being scaled back, but output for 2015 is still set to rise. Beyond that, though, whether the US will maintain output given ultra low prices or whether output is cut back will have a big impact on global oil supplies and prices.

China. China is the second largest consumer of oil and the largest importer of liquid fuel, and may account for as much as a quarter of global oil demand growth through to 2020. In 2014, the Chinese economy grew at its slowest rate in 25 years. How fast China grows will have a big impact on oil prices. Faster growth in China means higher global demand for oil and higher prices.

OPEC – and especially Saudi Arabia – has of late decided not to cut production quotas in the cartel. For how long will it continue to do that?

Conflicts used to have a big impact on oil prices, and will no doubt do so again in the future. At the moment, given the scale of global over-supply, conflicts in Libya and Iraq are currently seen as less relevant, and have been shrugged off by oil markets.

Previously they would have probably led to oil price spikes. That could change if, over time, global supply is scaled back in response to low oil prices, and geopolitical tensions may again become a major factor impacting on oil prices.

The views and opinions expressed in this article are those of the author(s) and do not necessarily reflect the official policy or position of The Information Daily, its parent company or any associated businesses.

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