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| Michael Zienchuk, MBA, CIM Manager, Wealth Strategies |
… oil fell down and broke its crown, and gas came tumbling
after.” We’re stealing from a popular
children’s nursery rhyme about Jack and Jill, but in today’s energy market and
financial environment our interpretation seems appropriate. Over the past six months oil prices have
plummeted, with the past two months at an accelerated pace. The chart below, from InfoMine.com outlines
the price for a barrel of Brent Sea crude.
West Texas Intermediate, or WTI, the U.S. oil benchmark, fell well below
$60.00/barrel by market close on December 15, 2014. Crude prices fell by 25% from mid-June to the
start of October, but since then have fallen by another 33% roughly from beginning
of October to the middle of December.
What is causing this abrupt and aggressive drop in the price
of oil? We have heard that many believe
it is the U.S. looking to cause financial pain to Russia for its illegal and
deadly actions in Ukraine, from declaring the Crimean peninsula part of Russia,
to providing military weapons and personnel to the terrorists in eastern
Ukraine. Part of the above statement is
true – the part where the U.S. has played a role in the current weakness in oil
prices. But it is not due to actions
directly targeting Russia.
U.S. Oil Production
is Rising
After decades of falling oil production, the U.S. has
recently ramped up oil production a tremendous amount, beginning to reach back
to their historical high levels over the last ten years. U.S. oil production peaked in the late 1960s
– early 1970s period at over 9 million barrels/day. From that period to 2005, oil production in
the U.S. had been on a steady decline, falling to a low of less than 5 million
barrels/day by 2005. However, with
technological advances in opening up trapped oil and gas in shale plays.
By January 2014 US oil production had reached more than 8
million barrels/day production, while currently they broke the 9 million
barrel/day mark for the first time since the early 1970s. The U.S. is now producing more oil than Saudi
Arabia, making it the largest producer of oil in the world after Russia, who by
the way have been increasing their oil production aggressively over the past 14
years, from 6 million barrels/day in 2000 to over 10 million barrels/day today.
Weak Oil Prices to
Help Global Growth
Another argument about why the dramatic drop in oil prices
has been linked to the efforts to stimulate global economic growth. China’s economy has slowed down significantly,
barely over the mid-single digit GDP growth, far off the highs of 11% - 12% in
the early 2000s. This slowdown has hurt
their demand for raw materials in general, including oil. Look at the general collapse in commodity
prices, which reflects the weaker state of Chinese economic growth. The argument about low oil prices being a
tool to help stimulate global economic growth goes along the lines that all the
countries who cooperate have been trying to stimulate economic growth where
they can. The U.S. has provided massive
financial stimulus, as have the Europeans, while the ball has now shifted into
the middle east’s court, where lower energy prices will help improve corporate
cost structures and lower the impact on consumer’s disposable income, providing
a stimulus to demand growth and potentially job growth. This seems plausible, but would require more
research to find direct evidence of this.
With the recent OPEC meeting resolving nothing (those countries hurting
most requested the Saudis to cut production, which they in turn refused), it
appears that weak global demand combined with surplus production is taking its
toll on oil prices.
Finally, with the Federal Reserve signalling an end to its
monetary stimulus with its last purchases of financial assets in October 2014,
while major market investors expecting interest rates to be hiked by mid to
late 2015, much of the extended spike in oil prices could be attributed to
excess financial liquidity chasing oil prices higher. With that liquidity drying up, less financial
dollars are available to pursue oil futures, acting as an additional
deflationary force on oil prices.
Even the Oil
Companies Get It Wrong
Funny, just back on October 17, 2014 Reuters reported that
Schlumberger Ltd., the world’s largest oilfield services company, expected that
oil and gas spending would increase in 2015 as global oil demand was poised to
rise. Schlumberger management stated that
they saw global oil demand growing by 1.1 million barrels/day in 2015, matching
the International Energy Agency’s (IEA) estimate for oil demand growth. The IEA had lowered their expectations for
2015 growth from 1.4 million to 1.1 million.
At that time oil prices were around $87/barrel for Brent crude, while
now it is $62/barrel. One suspects that
the lower oil prices may be indicating demand for oil will be revised lower
again by the beginning of 2015.
Michael
Zienchuk, MBA, CIM
Investment
Advisor, Credential Securities Inc.
Manager,
Wealth Strategies Group
Ukrainian
Credit Union
416-763-5575
x204
www.ukrainiancu.com
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