5 Questions About The Collapse of Oil Prices

Many U.S. firms will actually drill more to make up for low oil prices.
Many U.S. firms will actually drill more to make up for low oil prices.
Billy Hathorn / Wikicommons

Oil prices are cratering, hitting just $30 yesterday, and what happens next is hard to predict. While some ideological enemies of crude might shrug their shoulders at this news, North Texas has a very good reason to keep an eye on these prices and trends. Dallas is home to a bunch of energy producers and infrastructure firms, small and large, and that means jobs. Beyond that, every consumer and business feels the influence of oil prices on their lives and wallets. So it's good to know why the numbers are dropping, and what it all means.  

1) How low can it go?

Yesterday, the U.S. Energy Administration Administration forecast the price of the U.S. benchmark West Texas Intermediate, or WTI, to average $38.50 for 2016, down from $51 in the prior month's forecast. That $12 difference is a big deal for U.S. oil and gas production firms.

The last time $30 oil was touched was in late December 2008, when the financial crisis was in full swing. Before that, it was December 2003. Given that most producing firms and countries need a break-even oil price greater than $40 to operate with any profit, according to Rystad Energy analysts, my guess is that the $30 oil price will not be here to stay. Bankers and other watchers are pegging the WTI benchmark to average $48.The stock market is punishing oil, but the economics and the sentiment on Wall Street are in a state of disconnect.

2) What is the oil industry doing to weather the storm?

For one, firms have focused on efficiency and shoring up balance sheets to weather the storm. Oil gas exploration and production firms actually have a mountain of long-term debt to work through — $353 billion estimated in December 2015. The pain the industry is feeling is real. The rig count was down from 900 by mid-year 2015 to 700 at year-end. It will likely fall further. Layoffs are being announced weekly by large oil-producing and oilfield services firms. But the industry is reacting to the low prices by merging and restructuring and private equity investors are coming off the sidelines to grab opportunities that emerge, to the tune of an expected $100 billion.

3) What's going on to cause prices to slide?

For one, the Organization of Petroleum Exporting Countries (OPEC) happened. OPEC has effectively been a cartel, wielding its influence over oil prices for decades. OPEC members, like Saudi Arabia (the kingpin), Iraq, Iran, United Arab Emirates and Kuwait, control roughly one-third of global oil supply. To bring up oil prices, previously OPEC would hold off oil supply, restricting it. But in late November OPEC did the unthinkable: they let the market decide, which essentially pulled the floor out from under oil prices. (But not exactly, because they began pumping more oil than their "quota" of 30 million barrels per day.) 

In fairness, oil prices were already starting to decline, slowly, by summer 2014. Other forces were weighing on a market that was becoming too heavily supplied. For example, the U.S. hinted at lifting the ban on U.S. oil exports, meaning more U.S. supply and a reduction of foreign oil imports. The Euro-zone's economic outlook was softening. And China's growth forecasts were being revised downward. All of these things helped weigh down the price of oil, but OPEC's influence is the real key. Prices have declined about 70 percent since summer 2014, from a high of the global benchmark, Brent, at $115 a barrel in mid-June 2014, to $45 by mid-January 2015 to now $30.

4)  Will nations that rely on oil revenue, like Saudi Arabia, suffer as well? 

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The low price of oil has influenced the Kingdom; they even reduced their production by 400,000 in August of 2014. OPEC's moves have damaged the Saudi budget. According to a 2015 analysis, the Kingdom needs a $103 oil price just to break even. They are spending reserves and borrowing more money, which they can afford for a time. Last year, a succession change in leadership in the Kingdom to King Salman and deputy crown prince Muhammad bin Salman, his 30-year-old son, brought new policy changes. Importantly, these include diversifying the state's budget away from oil, privatizing some oil-related assets and other late-20th century upgrades to its economic policy. Low oil prices have given the royal family the political cover to make some of these painful but overdue adjustments. 

5) So, do low oil prices mean less drilling? 

Some will drill less. But with such low oil prices, other U.S. firms may be incentivized to pump more volume to make up for poor pricing. That’s why a company like the Dallas-based Pioneer Natural Resources continues to be one of the bright spots in the energy industry, relying on its lower-cost inventory of resources pumped from the Permian Basin, deep in the heart of West Texas, to survive the price collapse.


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