Economics / Finance / International Business

Reduce Oil Production…or Die Trying

Alright we probably won’t die trying to reduce oil production. However it’s looking almost impossible to reach a solution in the near future. Markets are reeling from the decline in oil prices, and investors are definitely worried about the condition of the oil industry moving forward. Amid the bearish outlook, companies are laying off workers, and oil production is getting more expensive as this situation worsens. However, for some reason not one of the world’s major oil producers is cutting down production. There have been talks about a potential freeze, but, a major cut in production would really be the key to stabilizing oil prices. Cyrus Sanati from Fortune stated:

iea“Last year, the world produced, on average, around 1.8 million barrels of oil per day in excess of global demand. Those extra barrels went into storage tanks, adding to the glut in oil stockpiles across the globe, particularly in North America. There is currently around three billion barrels of oil in commercial storage tanks across the world, according to the International Energy Agency, a record. That is equal to around a full month of global oil consumption (which is a lot). So for prices to rise, the market needs to not only knock out the overhang in production, it also needs to eat away at all the oil in storage tanks as well.” [1]

There is so much oil in production right now, that there are rumors of the world running out of space to store it. Major media outlets have reported on the possibility of shortage of space to store oil. That could further drive the price of oil down into the teens. However, the United States still has 100 million barrels of storage available and China will gain 230 million barrels in oil storage by the end of the year. [2]The world consumed about 94 million barrels of oil per day in 2015. That number is forecasted to increase to 95 million barrels of oil per day in 2016. That is good news considering stagnant or decreasing oil consumption would increase the supply of oil at year’s end. [3]

sa-oil-ministerCountries are considering cutting production, the problem is that they don’t trust each other to follow through. Ali al-Naimi, the Saudi oil minister, said “There is less trust than normal…Not many countries are going to deliver. Even if they say they will cut production, they will not deliver.” He also said that a cut in production will not happen. [4] The Iranian minister of petroleum, Bijan Zangeneh, said that they plan increase oil production by 250 thousand barrels per day by the end of the year. In addition, Zangeneh also said this to an energy panel in Tehran:

“This is more like a joke that they tell us they would freeze their production above 10 million bpd and that we should also in turn freeze our production at one million bpd.” [5]

This illustrates the biggest issue with solving the issue of overproduction, it would require a globally concerted effort to combat the problem. Every nation still has to look out for itself in the long run. Sure, it would be nice to find a solution that could satisfy the needs of everyone, however, this is economics. It may become less profitable to continue to increase production as the price of oil drops. However, for some nations this is the backbone of their economy. These nations will continue to increase production, because, “any profit is better than no profit.”

Speaking of economic reliance on the oil industry, many nations not at the forefront of this problem are suffering heavily from the drop in oil. Places like Nigeria, Angola, and Venezuela are taking heavy losses because of the drop in oil prices. Oil can sometimes account for as much as half of the economic output of these nations. The recent trend of low borrowing rates, has led to great investment in commodities such as oil. However, the markets are now suffering and many oil-dependent nations are feeling the pressure.

eiaThe phenomenon of oil prices having a considerable effect on the stock market isn’t new by any means. The U.S. Energy Information Agency released a study that observed the relationship of the oil sector and the S&P 500 from 2004 to 2014. Over that period of time they found that there was roughly a 30% correlation between oil prices and the index. What does that mean? It simply means that around 30% of market fluctuations can be attributed to oil. There is still another 70% that isn’t accounted for.[6] Currently, the correlation has jumped to around near 100%. Yes, that means that the slightest dip or gain in oil prices can significantly affect the market.[7] Could that be due to a stark rise in oil dependence? Is the oil industry suffering the consequences of being highly overvalued? Are investors basing their decisions off of oil prices and skewing the flow of the market? To be honest, no one honestly knows the answer to any of those questions. We do know, however, that oil is cyclical. From June 2014 to January 2015 oil prices plunged by more than $50 dollars. The S&P 500 and the DJIA (Dow Jones Industrial Average) experienced steady gains throughout that period. Why didn’t the drop in oil lead to a market downturn. Again, the answer for this one specific instance won’t do much in predicting the outcome of our current situation. It shouldn’t be a surprise that the stocks of oil companies are highly responsive to, you guessed it, the price of oil. How the market responds to that is dependent upon way too many factors to try and honestly quantify its effect. At this point, it may seem like the only feasible solution, is to not look for one. The world may have to wait this one out until the end. The scary thing is we just won’t know where the end will be until we get there.


Sources:

[1] http://fortune.com/2016/02/23/oil-prices-saudi-arabia-russia/

[2] http://oilprice.com/Energy/Energy-General/The-World-Is-Not-Running-Out-Of-Storage-Space-For-Oil.html

[3] https://www.eia.gov/forecasts/steo/report/global_oil.cfm

[4] http://www.businessinsider.com/ali-al-naimi-shuts-down-saudi-oil-cut-2016-2

[5] http://oilprice.com/Energy/Crude-Oil/Iranian-Oil-Minister-Calls-OPEC-Production-Freeze-A-Joke.html

[6] http://seekingalpha.com/article/2528765-the-s-and-p-500s-historical-relationship-with-the-price-of-oil?page=2

[7] http://seekingalpha.com/article/3807356-high-correlation-stock-oil-prices-warning-sign?li_source=LI&li_medium=liftigniter-widget

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