With global oil supplies already at excess levels, producers continue to pump as much as they can, while they can. Contrary to some forecasts, cheap oil has not been a boon to the entire global economy that it could have been. More pumping will not help matters.
By Vikram Rangala
Friday, January 22, 2016
The island of Kharg, about 16 miles off the coast of Iran, has been home for several months now to half a dozen or so oil supertankers. They are as long as skyscrapers are tall and hold a few million barrels of oil each. Iran’s Persian Gulf coast has more such flotillas, estimated to hold up to 50m barrels of Iranian crude.
As Iran begins to sell oil again after the lifting of sanctions, it will be at prices barely $10 a barrel higher than when the US imposed sanctions in 1995 and $20 lower than when the United Nations imposed sanctions in response to its uranium enrichment program. Now Iran has curtailed its uranium enrichment and those tankers are ready to set sail.
Oil prices have risen 21% in the last two days to over $32 a barrel on Friday, without any particular news item to drive it. Most traders point to oversold conditions and resting buy stops triggered when short sellers took profits. It represents a dramatic bounce from Wednesday, when crude crashed to as low as $26.19 a barrel, the weakest level since April 2003. That's a remarkable 21% surge in the span of just two days, but it’s still just a bounce.
Why has Iran been storing oil on tankers offshore instead of on land? It ran out of room. And Iran is not alone. The International Energy Agency says global stocks soared in the fourth quarter of 2015 by a record 1.8m barrels a day. They usually drop during winter in the northern hemisphere.
The US is close to its oil storage capacity as well, with only another 100m barrels available, says the IEA. The world is adding only 230m barrels of land-based capacity in 2016. The rest will go onto tanker ships until those fill up as well.
It’s no secret that Saudi Arabia has forced this overproduction in part to keep Iran from gaining market share and in part to “sweat out” North American shale oil producers, whose cost of production is well above $30 a barrel. While those producers can’t make a profit in the current environment, Saudi Arabia’s break-even price is only about $15, according to Rystad Energy and others. Iran’s break-even is estimated to be right about the current global price.
Cheap oil is not the boon to consumer spending that it was expected to be. While oil-importing countries like India and Germany are seeing GDP growth, it isn’t enough to offset the hurt to oil producers with high break-even costs. This is a greater problem because many of those high cost producers, like Russia, Venezuela, and Egypt, are already in economic dire straits and therefore vulnerable to civil unrest. Civil unrest is never good for global GDP.
Falling oil prices have caused some energy bonds to be downgraded to junk status, energy stocks to tumble, and suppressed the incentives to battle climate change, all while giving the world a lot more fossil fuel to burn. The US has missed its targets for production of electric cars, while sales of gas-guzzling SUVs are still going strong. Consumers looking at cheaper gas bills are not going to think long-term.
The oil in all those tanks and tankers will have to be burned at some point. So will all the oil that producers will continue to pump in a frenzy to get whatever income can still be gotten in this price war.
That is where the real high price of cheap oil lies. The costs of all that burning and the consequences of weakened markets and economies are not likely to be offset by economic growth in oil importing countries. In the long run and even right now, these bargain prices are too expensive.
This information has been prepared by Nadex, a trading name of North American Derivatives Exchange, Inc., prepared by independent third parties contracted by Nadex or reproduced form third party news agencies. In addition to the disclaimer below, the material on this page does not contain an offer of, or solicitation for, a transaction in any financial instrument. Nadex accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication.