July 2016, Vol. 243, No. 7
Features
What Lies Ahead for Oil Prices
Oil prices are measured in 42-gallon barrels. The history of this tradition dates back to 1866, soon after Edwin Drake drilled the first oil well in the United States in Titusville, PA in 1859. In 1866, a group of independent oil producers met in Titusville and decided that the 42-gallon barrel was the best way to transport oil. At that time, barges floated barrels of oil down the Allegheny River to Pittsburgh on the way to be refined into kerosene. The adoption of this standard for oil measurement stuck, and today oil is still measured in 42-gallon barrels.
The most fundamental determinant of oil prices is supply and demand. When the demand for oil exceeds supply, oil prices tend to rise, or to remain high, on a relative basis. When supply exceeds demand, however, oil prices tend to decline, or remain low, on a relative basis.
Of course, there are many other factors that influence the price of oil in addition to the balance of supply and demand. These include currency fluctuations, sudden disruptions in major sources of supply, political factors, bad weather, such as hurricanes and disasters such as oil spills. All of these factors can cause oil prices to spike or plummet on a temporary basis. Usually, though, these effects are temporary and oil returns to the price dictated by the balance of supply and demand.
3 Benchmark Oils
Before exploring the effects of supply and demand on today’s oil markets, it is worth looking at what is meant by “the price of oil.” While there are many types of oil, three types have become benchmarks for the oil markets. These are West Texas Intermediate (WTI), Brent and Dubai/Oman.
WTI is traded on the New York Mercantile Exchange. It is composed of oil extracted in the United States, mainly from fields in Texas, North Dakota and Louisiana. WTI is light and sweet and has a low sulfur content. WTI is transported via pipeline to Cushing, OK where it is refined.
Brent crude oil is mainly extracted from four oil fields in the North Sea: Brent blend, Forties blend, Osberg and Ekofisk. While it is considered to be both light and sweet, it is slightly heavier than WTI. Brent futures are traded on the ICE Futures Europe in London.
Dubai/Oman oil refers to a “basket” of oils from Dubai, Oman and Abu Dhabi. It is heavier than WTI and Brent oil, and is slightly sour. Dubai/Oman oil has been traded on the Dubai Mercantile Exchange since 2007 and has become a benchmark for oil shipped to Asia.
Source: Energy Information Administration (EIA)
It should be clear that the per-barrel price of WTI crude oil remained mostly between $80-100 from Jan. 3, 2011 until August 2014 when it began a steady decline from the $100 level, down to the range of $30 per barrel. While some of the fluctuations were due to the Arab Spring uprising, hurricanes in Louisiana and to other events that temporarily affected oil prices, the fluctuation mainly reflected a supply-and-demand story.
Source: EIA
Note for most of the time prior to August 2014, the red line is above the blue line, meaning that demand exceeded supply during most of this time. Beginning in August 2014, the blue “total supply” line exceeds the red “total consumption” line, meaning supply then began to outpace consumption. But this is exactly the time when oil prices began to decline.
This is seen more clearly by comparing the actual numbers from July 2014 to March 2016.
Source: EIA
In July 2014, world oil demand exceeded supply by 0.18 MMbpd. Then in August 2014, oil supply exceeded demand by 0.86 MMbpd. Since then, world oil supply has exceeded demand and oil prices declined from $98 to the $30 range. In March 2016, world oil supply exceeded demand by 1.45 MMbpd.
Who’s Producing All This Oil?
Of course there are other factors involved in oil prices besides the supply/demand equation. But there does appear to be a pretty close correlation between oil prices and the balance of supply and demand. So who is producing all this oil? And if there is a reduction in supply, will this bring oil prices back to a level where it is profitable to drill in more locations once again?
Let’s study world oil supply through the prism of OPEC (Organization of Petroleum Exporting Countries) and other non-OECD (Organization for Economic Cooperation and Development) countries, and the OECD countries.
OPEC
Formed in September 1960 at the Baghdad Conference, OPEC’s founding members were Iran, Iraq, Kuwait, Venezuela and Saudi Arabia. Eight other countries, including Nigeria and Algeria, joined OPEC later. One purpose of OPEC has been to influence oil prices by controlling production, thereby keeping prices at a desirable level. This has changed recently beginning in November 2014 when OPEC declined to cut production to prevent oil prices from coming down further after the decline began in August 2014.
OPEC, led by Saudi Arabia, has stood firm since then, maintaining or increasing production levels. As a result, oil prices continued to decline to the range of $30 in February 2016.
OECD
Founded in December 1960 by 20 countries committed to democratic government and a market economy, OECD has since added 10 additional member nations. Some of the more prominent members include the United States, Germany, the UK, France, Australia and Japan.
Source: EIA
Though OPEC accounts for the largest portion of the non-OECD supply, this amount includes other countries besides the 13 members of OPEC. The second-largest contributor to non-OECD supply is production from the Former Soviet Union and from China. Neither of these countries or regions are part of OPEC. An assortment of other countries comprise the remainder.
Looking closely at non-OECD supply in 2015 and 2016, it becomes clearer what constitutes the non-OECD portion of the total world petroleum supply.
Source: EIA
Source: EIA
The crude oil production for the United States in January was 9.18 MMbpd, putting it about 800,000 bpd behind Saudi Arabia, according to EIA data. Most analysts attribute the increase in U.S. production to the advent of shale oil technology. Through the process of hydraulic fracturing, it is possible to obtain oil from wells that were once thought to be “dry,” or non-productive.
This process has significantly increased the total crude oil from the U.S. and other countries. Fracking has become controversial, due to its environmental effects, which are still being studied. Even so, the advent of the technology of fracking is a major reason for the increase in oil supply, and for the imbalance of supply and demand.
Will Oil Prices Rise?
One of the countries hurt worst by low oil prices is Russia. Russia is not part of OPEC, but is a major oil producer that relies heavily on oil revenues for its income. Russia’s economy shrank by 7% in 2015, due in part to lost oil revenues from lower oil prices. According to President Putin, his country calculated its 2016 budget based on $50 oil. Oil prices dropped below $50 in July 2015, and continued to decline until recently.
In late January, Russia’s Energy Minister Alexander Novak claimed Saudi Arabia proposed a global production cut of up to 5%. He said Russia would be willing to discuss the idea, which would presumably involve an extraordinary meeting of OPEC members. Oil prices rose by as much as $5 per barrel to $34 in late January and early February, based on comments from Russia. The remarks appear to have been a case of “jaw-boning” by the Russian minister, since OPEC officials denied any plans for an emergency meeting. Oil prices fell again once it appeared no meetings were in fact planned.
Output Freeze Discussed
Despite the lack of credibility of Russia’s initial remarks about a cut in production, the comments seem to have served the purpose of getting some of the major oil producers to start discussing the topic of high oil prices and what can be done about them.
In mid-February, four large oil producers, Saudi Arabia, Qatar, Russia, and Venezuela, met in Doha, Qatar and agreed to freeze production at January levels if other countries would go along. Qatar holds the rotating presidency of OPEC. Kuwait later joined the agreement which Iran blasted as a “joke.” Iran is ramping up production, now that international sanctions have been lifted and is expected to increase its output to 3.6 MMbpd by mid-2016. At the same time, Saudi Arabia has reiterated it has no plans to cut production.
The discussion of a freeze did seem to have a short-term effect on oil prices. In March, prices briefly topped $40, while in April 2016, prices were above $40 much of the month. But this may have more to do with the slow decrease in supply along with some increase in demand.
There were also some unexpected supply disruptions during this time. Even a drop of 500,000 bpd can have a significant effect. The EIA forecasts world petroleum production will increase by over 400,000 bpd in 2016. At the same time, the organization is forecasting demand will increase over 1.2 MMbpd during 2016. This would result in a change from a 2015 surplus of supply over demand of 1.8 MMbpd to a surplus of just over 1 MMbpd in 2016. This difference alone should have a positive effect on oil prices (see table “Global Petroleum and Other Liquids”).
In March there was discussion of a meeting of the major oil producers between March 20 and April 1 to be led by Russia and Saudi Arabia. Iran’s lack of interest in a production freeze delayed the meeting and it did not occur.
On March 16, the Qatari minister announced there would be an April 17 meeting in Doha, Qatar of major oil producers. It was held as scheduled and involved 18 oil-producing countries. Chief among these were Saudi Arabia, Russia, Qatar, Oman and other OPEC countries. After 12 hours, the countries could not agree on a freeze. The chief stumbling block appears to have been Saudi Arabia’s insistence that Iran join such an agreement. Iran, which did not attend the April 17 meeting, is determined to bring its oil production back to pre-sanction levels before it is willing to discuss or implement a freeze.
Prior to the meeting, WTI was selling for just above $40. While oil initially sold off by several dollars after the collapse of the potential agreement, it rebounded, closing above $40 on April 19. Since then, the price of oil has mostly been in the $40-45 range.
While a freeze agreement would have lent some stability to the markets, it is doubtful that it would have had a major effect on oil prices. A freeze at January 2016 levels, while an important psychological effect, is not the same as a cut in production. Saudi Arabia, most importantly, remains unwilling to cut production, although it has maintained production at a fairly constant level.
It seems the markets are doing the job of narrowing the gap between supply and demand, along with occasional supply disruptions. This should prevent oil prices from falling below $30. In reality, it seems likely prices will increase to the $55 range by September.
Effect on Flowmeter Markets
In March and April, Flow Research surveyed the main manufacturers of Coriolis, magnetic, ultrasonic, vortex and thermal flowmeters. The results for these five new-technology flowmeter markets indicated that only the magnetic flowmeter market showed an increase in 2015 from 2014, and this was its smallest increase in 10 years.
The other four markets declined in 2015 compared to 2014 in the range of 1-7%. This was primarily caused by declines in investments by oil and gas producers, especially for exploration and production.
For a full discussion of this subject, see Flow Research’s fourth-quarter 2015/first-quarter 2016 Market Barometer at www.worldflow.com.
What Lies Ahead
According to EIA forecasts, the roughly 1.8 MMbpd that world supply exceeded demand by in 2015 will narrow to about 1 MMbpd in 2016, and narrow further to 0.37 MMbpd in 2017. This will likely cause prices to rise gradually. A slow, steady increase of this type will eventually be seen as a sign of stability in the oil markets, and should encourage oil and natural gas companies to increase their E&P investments.
Author: Jesse Yoder, an internationally recognized expert in metering research, is a contributing editor to Pipeline & Gas Journal. He leads Flow Research, Inc., Wakefield, MA, and can be reached at jesse@flowresearch.com.
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