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The outlook for oil prices

Oilfield Technology,

According to Jadwa Investment (JI), Q3 2014 was marked by a sudden decline in oil prices, with the Brent benchmark dropping 7.3% in the quarter, to an average of US$ 102/bbl, down from US$ 110 in Q2 2014. The firm sees this decline coming about from a combination of accelerating US supply, resulting in a glut of light sweet crude in the Atlantic Basin, weaker than expected global demand, stabilization in geopolitics, and an appreciation of the dollar.

Although the growth of light, sweet US crude production has been accelerating in the last few years, global production outages in a number of countries have delayed the impact of US supply rises on oil prices. US production increased by 3 million bpd in the five years since Q3 2009, but outages in five countries (Libya, Iran, Yemen, South Sudan and Syria), totaling 2.4 million bpd, meant oil supplies that were no longer going to the US found alternative markets quite easily. However, since 2012 rising US oil production has been backing out imports of West African crude, mainly Nigerian. Nigerian exports, which are light and sweet also, totaled 1.1 million bpd to the US in 2007, but dropped to an average of 140 000 bpd in H1 2014 and the US imported no crude oil from Nigeria between 27 June – 8 August. As a result, a large portion of this unwanted Nigerian crude has contributed to creating a glut of supply in the Atlantic Basin, putting downward pressure on Brent prices.

The glut in West African crude has also come about at a time when concerns over geopolitical issues, which had previously maintained a floor on prices, receded. In Q3 2014, JI identified no major additional damage to oil infrastructure in Iraq as violence did not spread to the oil exporting areas in the south. The Ukraine-Russian conflict saw sanctions applied by both sides but these sanctions did not impact on short to medium oil supplies and, although conflict continued in Libya, oil output increased. As these key geopolitical even stabilized, the risk premium attached to oil prices decreased, pushing prices downwards.

Lastly, an appreciation of the dollar in the last two months has seen it reach its highest point in over a year which, in turn, has also contributed to decreasing global demand for oil and added to downward pressure on prices. Oil prices and the US dollar exchange rate have a negative correlation, since the global market for crude oil is generally prices in the dollar. Therefore an appreciation of the dollar is usually accompanied by a decline in global oil prices, due to decreases in demand as it becomes more expensive for non-US consumers, and vice versa. The current dollar strength is a result of the expectations of rising interest rates in the US, as the Federal Reserve ceases its asset purchasing program plus looser monetary policy implemented by both the EU and Japanese central banks, to support their respective economies.

Looking ahead to Q4 2014, JI sees oil prices recovering slightly on the back of an uptick in demand during the winter seasons, but ample supply from non-OPEC sources will see global oil surplus reaching 1.73 million bpd in 2014, therefore preventing prices from rising too far beyond the US$ 100/bbl mark. Furthermore, there is likely to be no let up in the strength of the US dollar, which will hold its elevated value, and JI do not foresee any significant cuts in OPEC production taking place. However, they do see any deterioration in geopolitics of Iraq, Russia/Ukraine and Libya resulting in oil prices recovering above US$ 105/bbl.

Adapted from a report by Emma McAleavey.

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