Three reasons why oil prices are falling

13 Aug

Or rather two: supply and demand. This is why oil prices are coming down, despite all the turbulence in the Middle East and the Ukraine-Russia conflict.

Imagine what would have happened to oil prices a few years ago if: there was an increasing chance of open war between Russia and Ukraine (and that Ukraine stops pipeline transports), the US bombed religious fanatics in Iraq who occupied oil fields and in general the Middle East looked like a powder keg? Now we are running exactly that kind of simulation, and….. oil prices dropped to a 13-month low. Brent is below $103 at the time of writing, and WTI is around $97 per barrel… How could this be?

oil_3004262b[1]Not exactly running out… Source: The Telegraph

  1. US oil production has been quietly but consistently increasing in the past few years by about 1 mbpa each year. That is more than 1% of global demand. And there is little sign of a serious slowdown. So in one word, it is shale oil. We wrote about this in more detail here.
  2. Oil supply did not really decline during all the political crises. Markets may well be shortsighted and too complacent here, but actual production has increased – Libya is recovering a bit, and Saudi Arabia is producing at a relatively high level.
  3. Demand growth is weak: the IEA just reduced its 2014 demand forecast to 1 million barrels per day. It is playing the same game as the IMF: the strong recovery is always a year away. But it would be high time to get used to relatively weak demand growth: in the 10 years to 2013 (roughly since when we have had high oil prices), average demand growth was 1.1 mbpd annually. New normal, stupid. And it looks like that big fat driver, Chinese demand, is slowing, and in our view the risk of a large financial crisis is increasing there.

The next few months will likely show how mistaken oil markets are at the moment. There may well be a large supply disruption, and oil prices could jump. But even the current news-flow would have resulted significantly higher oil prices a few years back, which is sign of a shift in the underlying fundamentals…

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