Oil Market Volatility : Fifth ‘Oil Shock’ on the Horizon

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--By Sanjeev Sharma
Unnerved by the spectacular fall in oil prices, the global market is struggling to shake off the recent rout. After hitting USD 115 per barrel on June 19, Brent crude, the global benchmark, has plunged more than 30 per cent since then, heading downwards USD 70 per barrel, the lowest in nearly four and a half years. Similarly, US crude, another major benchmark, has also nosedived towards USD 65/barrel from its June high of USD 106/barrel. The freefall has led to fears that the global oil market has now entered into uncharted waters and there would be unforeseen consequences to the economies of major oil producers should the price fall further. Market analysts are also worried by the announcement of price war against the US shale oil by the Saudi Arabia-led OPEC on its meeting in Vienna on 28th November. Their fears are driven by the probability that more volatility is likely to follow as producers are currently engaged in securing their market share by all means possible. As the cartel's Vienna meeting repeatedly refused to cut its crude output, some are even raising their concerns about the possibility of another ‘oil shock.’ 
 
Multiple factors are behind the slump in oil prices. Oversupply, falling demand and competition among OPEC and non-OPEC producers to increase their market share are seen as some of the key reasons. Similarly, a conspiracy theory has also developed to explain the decreasing price level which has largely been unproven but supported by some strong ground realities. In early October, the global market was awash with a rumour that an agreement between the US and Saudi Arabia was behind the volatility. Oil pundits alleged that the concord which includes far-reaching provisions such as over-supplying the global market uncut supplies was targeted against Russia and Iran who are also among the world's biggest oil producers. According to them, the purpose was to bring to their knees the economies of two nations which have been confronting the western powers over Ukraine and atomic issues. 
 
The cooling of Chinese economy and sluggishness in Europe are regarded as other reasons. China, which has overtaken the US as the biggest consumer of oil, is witnessing a decline in demand due to the gradual slowdown in economic activities. Recent data compiled by the British bank, Barclays, reveals that oil consumption in China has been following a fluctuating trend in recent months. According to the bank, oil demand in the world's second largest economy declined by 2.1 per cent in July compared to a year earlier. On a monthly basis, the slump was recorded at 6.2 per cent or 9.61 million barrels per day (bpd) from 10.25 million bpd in June. The demand which has been wobbling in after months is trying to adjust itself in the uncertainty. 
 
This situation, according to Barclays, is also being driven by China pouring a large portion of its oil imports into strategic stockpiling instead of consumption. China which consumes an eye-popping 10 million bpd, officially maintains its Strategic Petroleum Reserve (SPR) as an emergency fuel storage system with oil cache totaling 91 million barrels across four sites. The government has planned to increase the hoarding by 204 million barrels by 2020 which can provide uninterrupted supply oil for 90 days. Oil consumption in Europe, meanwhile, having slid to a 20-year low in early 2013, has also not fully recovered. Fewer vehicle sales and stagnant manufacturing sector coupled with EU's own decision to reduce the use of oil to lower carbon emission are acting as catalysts to this. 
 
 
Supply issue has been one of the major concerns in the global oil market. Events such as production cut, disruptions in supply due to geo-political upheavals and rising demand have always pushed the price of oil upwards, whereas, supply excess and lower demand and economic downturn in importing nations lower the petroleum prices. Looking back into time, we could see how different events have impacted the global oil market. For instance, Organisation of Arab Petroleum Exporting Countries (OAPEC) imposed an oil embargo on the United States in October 1973, in response to the US involvement in Arab-Israel war, prompting the first global ‘oil shock.’ The export ban which ended in March 1974, saw the price of crude oil rise to USD 12/barrel from USD 3/barrel. Similarly, the second ‘oil shock’ came in 1979 when crude oil prices dramatically increased to USD 40/barrel from USD 14/barrel within a year due to the production cut in Iran in the wake of the Islamic revolution. 
 
The decade of 1980s again witnessed price volatility following the start of Iraq-Iran war. Despite the fact that the war forced the two oil majors to nearly stop or severely cut their production, petroleum prices fell as demand in the western hemisphere slid as other producers came to the rescue with their ample supplies. During the mid 80s, price of crude oil came down substantially from USD 27/barrel in 1985 to USD 12/barrel in 1986. Oversupply also led to the decline in global oil consumption as well. The third 'oil shock' following Iraq's invasion of Kuwait in 1990, however, was more subtle than the previous crises. Its impact lasted only for nine months propelling the per barrel oil price from USD 17 in July to USD 36 in October of that year. When the war was over with Iraq's defeat, the declining trend continued for another 14 years, eventually reaching a fall-off during the 1990s. During the period, OPEC, the global oil monopoly, on several occasions tried to impose production-cut but it was largely ineffective due to the emergence of non-OPEC countries such as Russia, Mexico, Norway, Brazil, Canada and United States into the global energy scene. The massive extraction of Brent crude from Europe's North Sea also began to mount strong challenge to the superior dominance of OPEC's oil. 
 
The fourth 'shock' was instigated by the financial crisis in 2008. The overheated crude price which peaked to an all-time high of USD 145/barrel due to concerns over the long-term supply in July 2008, sharply declined after the collapse of American banking giant Lehman Brothers. By January 2009, the global oil demand had fallen to an all-time low with the price plunging to USD 32/barrel. However, the start of the Arab Spring in late 2010 followed by the growing tensions over Iran’s atomic programme later caused supply disruptions, thus pushing the price up. In 2014, the outbreak of Ukraine crisis and fears regarding the progression of radical Islamists in Iraq and Syria were seen as the reasons supportive to the rising oil price. 
 
The current oversupply is largely related to the rising production in North America. The shale or the 'tight oil' boom, mainly in the US and partly in Canada, is causing the market to overflow. After the decision of the US government to lift its long-time ban on hydraulic drilling or 'fracking' in 2008, producers across the country have been rushing to extract the oil trapped in the sedimentary rocks beneath the earth's surface. Due to the outburst of fracking activities, the US for the first time in history became net exporter of oil in 2013. Production in the US has surged 70 per cent since 2008, adding 3.5 million bpd. The increase is more than any OPEC member produces other than Saudi Arabia.
 
The fall in oil price signifies the loosening of OPEC's market grip, forcing the cartel to the crossroads. The 12-member group that produces 30 million pbd or one-third of the global demand is said to be losing USD 1 billion on a daily basis. Similarly, the internal rift in OPEC is also intensifying as smaller producers within the organisation are hard-hit by the price downfall. Members, particularly, Nigeria, Algeria and Venezuela are expressing their discontent towards Saudi Arabia's policy to continue production at current pace.
 
The ongoing price slump carries broader impacts. The energy hungry world now possesses the ability to enjoy oil at affordable prices. The economies with wider trade imbalances can now tame their deficits caused by the higher cost of oil imports. The prices of gold and other commodities are also likely to come down further as cheaper oil eases their production costs. Airlines and transportation sectors are particularly seen benefitting from the low-priced oil. The volatility has positive impacts for some while other may experience a hard punch. "The low price of oil is good news for the US economy, because it implies higher real incomes for American consumers," notes Martin Feldstein, Professor of Economics at Harvard University, in his latest Project Syndicate article entitled "The Geopolitical Impact of Cheap Oil." The esteemed professor who chaired President Ronald Regan's Council of Economic Advisors from 1982 to 1984 further writes, "Within the US, the lower price is transferring real income from oil producers to households, which raises short-term demand because households spend a higher proportion of their incomes than oil firms do. For the same reason, the lower price also gives a boost to aggregate demand in Europe, Asia, and other oil-importing regions." 
 
Nevertheless, various risks are also associated with the price fall. The tussle between the OPEC and non-OPEC nations is expected to hamper their own economies. Experts are saying that anything below USD 60/barrel would spell trouble for the US shale industry. This would make the extraction unviable as the per barrel production cost of 'tight oil' is currently hovering just over USD 60. Similarly, the oversupplied global market risks a 'peak oil' scenario which may eventually result in the production decline and price rise in the near or medium terms. The price slump also carries upshots to countries such as Russia as Prof Feldstein states, “A further decline in the price of oil could have major geopolitical repercussions. A price of $60 a barrel would create severe problems for Russia in particular. President Vladimir Putin would no longer be able to maintain the transfer programmes that currently sustain his popular support. There would be similar consequences in Iran and Venezuela.”
 

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