In mid-January, crude oil prices fell below $30 per barrel for the first time since the early 2000s, causing widespread shock throughout the global markets.
In the U.S., the low prices have contributed to a wave of bankruptcies among high-cost producers who are suddenly operating at a steep loss. In 2015, 39 oil field service companies filed for bankruptcy, representing more than $5 billion in debt. But that’s still just 5% of the hundreds of middle-market oil field service countries, according to Haynes and Boone. The analyst firm believes that 20% of the market may need some kind of restructuring.
Low crude oil prices have also caused mayhem in the global markets. With oil revenues in decline, Russia’s ruble has collapsed by 12% so far this year, and Azerbaijan was forced to abandon its currency peg and devalue its currency by 30% last month. The drop in revenue has also put pressure on national governments that have historically relied on oil revenues to finance their public budgets and provide social services to citizens and subsidies to the economy.
The dramatic decline is attributable to Saudi Arabia’s decision to maintain record production and the unwillingness of other countries to cut back production – but just how far will OPEC let oil prices drop before intervening in the market?
Saudi Aramco Won’t Go It Alone
Saudi Aramco is the largest crude oil producer in the world with the lowest cost of production by a wide margin and zero debt on its balance sheet. While the real cost of production isn’t public, many Western experts agree that Saudi Aramco produces oil at between $10 and $20 per barrel compared to the $40 to $50 per barrel that it costs U.S. producers. The country has also stored about $750 billion in reserves to give it wiggle room during this downturn.
While higher oil prices could help Saudi Arabia in the long term, the government is hesitant to increase production for two big reasons. First, the country doesn’t want to give up market share by being the only country cutting production. If other producers were to cooperate, however, Saudi Arabia would consider collaborating. Second, lower prices could force higher-cost drillers in the U.S. out of the market and stabilize prices without cutting production.
The good news for crude oil bulls is that the cooperation appears increasingly likely. With crude oil prices taking a toll on many countries in the Middle East, there’s a growing consensus that action needs to be taken to stem the decline and stabilize prices. Many of these countries require $50- to $100-per barrel prices in order to balance their budgets, which means that low oil prices are putting financial strains on their entire economies.
Potential Catalysts Ahead
The upstream oil industry reduced its investment by 20% last year and another 16% reduction is expected this year, according to officials from the IEA. These cuts could lead to a powerful spike in oil prices later on when the market stabilizes and/or when a deal is reached among OPEC and non-OPEC members to control the price. Such a move could cause another shock to the global economy in a very different way.
On the other hand, the lifting of Iranian sanctions has opened the door to 300,000 barrels per day and many desperate countries seem to be turning up production rather than slowing it down in order to increase gross revenue. The long-term picture also remains clouded because 70% of crude oil is consumed by the transportation industry, which is increasingly headed towards the use of electric vehicles and more efficient engines.
The Bottom Line
Crude oil prices have reached lows that haven’t been seen in more than a decade, but it’s unclear just how low OPEC will let prices fall. While Saudi Arabia seems content to let prices fall for its own reasons, other members of OPEC are increasingly looking to strike a deal to lift oil prices and improve their public finances. The long-term picture remains unclear, however, with a number of different factors in place, including Iranian production and reduced investment.