Producers unperturbed by falling oil prices
A 10 per cent fall in oil prices in just two months might have set off alarm bells for producers in times past, but the almost blasé reaction to the drop is a reflection of the markets’ comfort in recent years in dealing with geopolitical flare-ups.
The decline in benchmark oil prices from a peak above $115 a barrel in June to about $103 early this month has come while crises in important energy locations, such as Libya, northern Iraq and Ukraine/Russia have, if anything, intensified. But what is remarkable is not the recent drop in the face of such disruptions, but the fact oil prices have remained so steady over a long period: the current price for benchmark North Sea Brent is almost exactly the average price since 2011, and the fluctuation in oil prices has rarely been more than 10 per cent either side of $100 per barrel over that period.
As analysts at Bank of America Merrill Lynch noted: “Oil has not been this stable since the break-up of Bretton Woods in 1971”.
Also notable is that oil price volatility has declined at a time when regional equity bourses have become more sensitive to disruptions and, in contrast to the past, they have moved much more sharply in reaction to geopolitical events.
As the EFG Hermes analyst Mohamed Al Hajj, points out, regional bourses have shown a sharp decline in the wake of disruptions, for example, last August’s news about potential US air strikes in Syria, while oil prices remained more steady. This year has been a similar story, with much greater volatility in the regional equity markets than in oil prices (see chart).
There are complex factors behind the relative steadiness of oil. The most important consistent factor driving oil prices is the world economy.
“We do not expect oil price volatility to rise sharply as demand weakness in Europe and emerging markets will be balanced by regional instability,” said Mr Al Hajj.
That is a view shared by the International Energy Agency, the consuming countries’ think tank, as reported last week.
Bank of America Merrill Lynch also reckons that apart from macro-economic facts, the breakdown in the old Opec quota system in 2011 has been a major factor in stabilising markets. This has meant that, “In effect, key swing producers (Saudi, UAE and Kuwait) were handed a 5+ (million barrel a day) band to help balance” the world oil market, something that they have managed to do effectively.
As the key producing countries have become more adroit at anticipating and managing the supply-demand balance, they have been able to keep a comfortable cushion for oil prices in relation to their national budget breakeven oil prices (which for the UAE is about $74 a barrel, according to the IMF).
Another factor that is likely to be reducing volatility is that banks, such as Goldman Sachs, have retreated from the markets in the wake of the 2008 financial crises. The subsequent heightened scrutiny and cost of leverage put on such risky sectors has pushed them to sell up their physical oil assets and reduce sharply their related hedging activities.
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Published: August 17, 2014 04:00 AM