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‘Oil Break’ – Short Term or Here to Stay

Posted in Finance Articles, Total Reads: 1426 , Published on January 25, 2015

In 2005 Saudi Oil leader, Sheik Ahmed Zaki Yamani said, “The Stone Age did not end for the lack of stone, and the oil age will end long before the oil runs of oil.” Discovery of shale and development in oil extracting technologies such as fracking and horizontal drilling is pressing hard to prove his statement correct.


In Oct 2014, an analyst at Goldman Sachs was heard quoting “there has been a shift in the structure of the oil business”. Goldman Sachs said that the ability of OPEC nations to control the price of oil is changing to US. ‘The new oil order’, article published by wall street journal said that it’s time for oil products in US, who are continuously drilling more wells in euphoria, to pace down because the demand for oil across the world is becoming weak and also the scenario is changing at a great pace. It was said that the price of oil to fall to $75 - $85 barrel by July 2014, however, it already $60.


For most of the spectators, it is astonishing that how in a short span of 8 months the oil price could drop so drastically. Well, is it this drop surprising? In last three years, United States has been the fastest growing producer of hydrocarbon products. Since 2010, United States has increased the production of natural gas by twenty-five pc.


As if this was not enough to affect the oil consumption and trade patterns in global energy markets and thus increase the pressure on OPEC nations, oil production grew by sixty pc since 2008. And since 2008 its production increased from 3mn barrel a day to 8mn barrel a day. It is expected that in few months oil production will surpass its old record of 10mn barrel a day. With this increase in the capacity of oil production by United States, the idea of oil break becomes more evident.


United States, which is the largest consumer of oil, decreased its oil consumption of oil by 0.3 pc in the last quarter. Since 2010 use of Petrol in US has dropped by 3.7 pc. Well, do not be surprised, with the advancement of technologies the mileage of US cars have improved up to thirty pc in last seven years. United States, Brazil and India are promoting the use of ethanol as a motor fuel. These advancements have together decreased the pressure on the consumption of oil thus decreasing the demand for oil.


The decision of OPEC nation to cut oil production is curious. The twelve nation bloc that had kept a tight grip on oil trade is no longer a powerful cartel. Its competitors are increasing year by year. Since its formation, two out of top three oil producing countries are outside OPEC. No longer has OPEC had control on oil supply at high price as it had in the days of 70s.


In recent Oil meeting in Vienna, OPEC decided to keep the output ceiling unchanged, even though, the supply of Oil has changed drastically. OPEC decided on changing their long- standing policy on oil price. Even if OPEC defers the oil prices, it would not create many ripples in the world market or even if manages to create ripples it would last more than a couple of months.


Other OPEC members wanted to decrease the supply to prevent the decline in oil prices, but Saudi Arabia followed another policy. The transportation comprises more than 55% of oil consumption on a global level. The increase in population and growth in the economy may lead to more number of vehicles in the near future. But this surplus is offset by the improved fuel efficiency of new engines and the increased use of alternate fuels.


OPEC members like Venezuela and Iran are already under enormous economic pressure. If OPEC tries to get rid of weak price by deferring, Venezuela and Iran will have to face significant budget pressures. It is in the favors of OPEC countries to live with the realities of decreasing oil price to some extend in order to control the development of Private oil sector in United States.

There is no climbing back for the oil price. The only this that very speculators have their eyes on is to what extend this oil price would fall. And the question that every economy is asking at present is will its effect will be a harbinger of prosperity or failure. So what do you this will the oil price fall below the world record of US $30.28?


This article has been authored by Kumar Keshav from IIM Udaipur


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