A New Oil Order

The International Energy Agency (IEA), a Paris-based autonomous intergovernmental organization which serves as an information source on statistics about the international oil market and other energy sectors, announced that oil inventories in the world’s developed nations have ballooned to almost 3bn barrels: this number represents a fresh record for global oil stockpiles and contributed to support the downward trend that the energy market has been experiencing since 2014, when the price for crude oil was still around $100 a barrel.

The data confirms the fundamental glut in supply and demand that has been driving oil prices towards multi-year lows: WTI and Brent were trading respectively at around $40 and $43 as of Friday 13th November, indicating a weekly loss of about 8%, the worst since last March. Shifts in both the demand and supply in the oil market have so far been the main (even though not the only) reason in driving oil prices to the current level.

On the one side, a major supply glut has been caused by the OPEC’s decision to keep production at record levels in order to retain its market share and compete with the booming US shale oil industry; at the same time the Russian Federation has been pumping oil at post-Soviet era highs to try and gain customers both in Europe and Asia, especially in China.

As the IEA recently reported, while production from outside the Organization of Petroleum Exporting Countries is expected to decline in 2016, record supplies from major producers such as Iraq, Russia and Saudi Arabia have flooded the market and “inflated the massive cushion” of almost 3bn barrels.

After the Iran nuclear deal was reached over the summer and an upcoming lift-off of international sanctions on the country’s exports, including oil, was announced, market participants started speculating about a further deterioration of the current supply glut, with Iranian oil supplies expected to flood the market as soon as January.

From the demand side, many factors have been influencing the price of oil. Even though demand has been overall robust in 2015, increasing concerns about the economic slowdown in China and across other emerging markets as well, have driven markets to expect lower demand for the commodity.

With the US and the UK economies reporting moderate GDP growth of 1.5% and 0.5% respectively in Q3, and while the Eurozone still experiences an extremely fragile recovery characterized by a fight against deflation, the news that the Chinese economy, which consumes the world’s largest amount of commodities, slowed to 6.9% caused financial markets to revise their expectations for oil demand downwards.

With global GDP growth forecasted to slow to 3.6% in 2016, the International Monetary Fund has warned that “downside” risks to the world economy have grown in recent months, further weighing on expectations of a further weakening on the demand side for oil.

The dramatic drop in oil prices has already had long-term, decisive effects on governments, especially in exporting countries, and on the corporate world.

The finances of exporters such as Saudi Arabia, Russia and South America have been put under great pressure, as most of the revenues for these countries rely heavily on oil exports; Saudi Arabia, in particular, whose foreign reserves have been falling due to the expanding budget deficit, is set to return to the bond market with a plan to raise $27bn by the end of the year.

South American countries such as Brazil, whose revenues are heavily dependent on several commodities, not only oil but also metals, saw a steep depreciation of their national currencies (read more about the impact of commodities market on emerging economies here!)

Oil and gas giants, on the other hand, have sought to fight the drop in prices and revenues by increasing efficiency: such objective has so far been reached through a revived M&A activity (as in the case of Royal Dutch Shell’s $55bn takeover of smaller rival BG Group) and through massive layoffs in the labor force, which in fact reached 200,000 globally in September.

With respect to future expectations about the oil supply and demand, the IEA forecasted that the market is still headed towards the downside, given that “the impact of oil’s steep price plunge on end users is unlikely to be repeated and economic conditions are forecasted to remain problematic in countries such as China“.

Oil price forecasts recently released by the International Monetary Fund and the World Bank hint at a new “Oil Order”, where the price of crude oil per barrel will stay below $100 well into 2020 and 2025 respectively.