Low oil prices are here to stay, says Vandana Hari

With crude oil prices falling by over 50 per cent to below $50 per barrel , Mahesh Nayak caught up with Vandana Hari, Asia Editorial Director at Platts, a leading global energy information provider and an independent price reporting organisation, to understand the reasons behind it.

Q. Did anyone see it (the crash in oil prices) coming?

A. While the fundamentals are now quite clear, it's interesting that nobody foresaw $50 (or lower) oil l ast June.

Q. So, why is oil slipping?

A. The reasons are now pretty clear and there are no disagreements over them. Burgeoning supply, especially with the US tight oil consistently adding close to a million barrel per day annually to the pool while the country's consumption remains almost flat. Canadian production has also been growing at a healthy clip.

In 2014, Russian output hit a post-Soviet high above 10 million barrel per day. And OPEC [Organization of the Petroleum Exporting Countries] production has consistently remained above 30 million barrel per day target for the past several months, despite the large fluctuations in Libyan output. Iraqi exports in December 2014 were the highest in 35 years. If the sanctions against Iran are lifted this year, the country could put an additional one million barrel per day of oil on the market.

Second, global demand growth is weakening. The US consumption has flatlined despite modest economic recovery. While demand has been shrinking in Europe for some time now, the Euro Zone's worsening economic quagmire portends a possibly steeper decline this year. The Latin American countries are facing fresh economic headwinds, too, leading to a bearish outlook on their oil demand growth.

Ditto Russia, which suffered a double whammy from western sanctions and the oil price collapse . And most importantly, China, the world's second-largest consumer after the US and the world's biggest engine of oil demand growth for the past several years, seems to be losing its appetite. Oil consumption in the country has slackened way more than GDP growth, now averaging an anaemic two per cent or so year on year.

Third, the strengthening of the dollar on back of the US economic recovery and widespread expectations of the Federal Reserve starting to hike interest rates this year. A stronger dollar means you pay less for commodities denominated in dollars such as oil. Also, it makes oil more expensive for the rest of the world, which pays with other currencies that are weaker relative to the dollar. That effect can also suppress the demand somewhat.

Q. There were different theories floating in the market for the fall in the oil prices like the biggies winding position in the market, the Russian theory, huge supplies from Iraq and Iran, the US slowdown and shale gas production. Which of these theories, do you feel, is the reason for the crash in oil prices?

A. The bearish momentum in my view built up with the confluence of following events. First, the 'fear premium' over the ISIS incursion in Iraq melted away quickly when it became evident that the militant activity could or would not spread to the southern part of the country, which is where most of the crude production and exports happen. Second was the multiple rounds of western sanctions against Russia that dealt a body blow to its economy...

The third reason was the dramatic slide in the US imports of especially light sweet crudes. When US imports of Nigerian crude dropped to zero in July 2014 - for the first time on record - the market took notice.  The combination of West African barrels being turned away by the US, while OPEC continuing to pump above its 30 million barrel per day target even as European demand was easing led to the so-called Atlantic glut, which became evident in consistently swelling inventories in the OECD [Organisation for Economic Co-operation and Development], as reported by the International Energy Agency.

Sometime in the second half of the year [2014], the market began digesting the notion that China's weak demand growth story, characterised by a historic contraction in its diesel demand and rising exports of the distillate in the first half of the year were the new normal rather than an anomaly. The oversupply that began in the Atlantic focused market attention more closely on Asia to see if it might be absorb the excess. And the markets concluded 'no'. That's one reason you see poor macroeconomic data from China over the past few months consistently knocking crude prices down from their perch.

Similarly OPEC's decision on November 27, 2014 to do nothing about rebalancing the markets, though foreshadowed to some extent, was a major jolt. The market consensus ahead of the meeting was that OPEC would need to cut by at least two million barrel per day if it were to mop up the excess supply that was weighing on prices. Not only did OPEC throw in the towel on that, but it didn't even address the gap between its 30 million barrel per day target and the projected 29.2 million barrel per day average "call" on its oil in 2015 as per its monthly report released earlier in November.

With the end of QE3 in October and as consensus took shape for a US interest rate hike sometime by mid-2015 based on statements from Fed meetings, the dollar began strengthening, lending further pressure to oil prices. Saudi oil minister Ali Naimi's epoch-making statement end-December that OPEC won't cut even if prices dropped to $20 signalled an all-out war and wiped out any lingering expectations the market had that OPEC might be forced to revisit its November 27 decision.

Q. With US expected to be energy self-sufficient by 2017, do you see huge geopolitical shift happening and what impact do you see in the energy market, especially oil?

A. The US net oil imports could reach zero between 2035 and 2040 under the Energy Information Administration's reference case projection outlined in its last annual energy outlook report in April 2014. The US' growing energy self-sufficiency makes it increasingly insular to geopolitical problems in other major oil-producing countries and industry watchers are contemplating Washington, D.C. becoming agnostic to any problems in the Middle East, for instance, that might threaten supplies from the region. As the US' oil supply grows while its domestic demand remains flat, the country is pushing out increasing amounts of refined products into Europe and Latin America and eyeing the Asian markets to sell condensates and LPG. Crude could join the list if the restrictions on crude exports are lifted.

The need to woo Asia as a customer base directly pits the US against major exporters of oil and gas, especially in the Middle East. As the refining capacity boom in Saudi Arabia and other Mideast regions gets well underway over the next five years or so, Europe could also become the battleground between the American and Mideast exporters of refined product. This could bring about a shift in the US' priorities from protecting Mideast oil flows from any threats and disruptions to guarding its customer base in Europe and Asia. In the world of oil politics, the US shale juggernaut has already emaciated OPEC. We could see the US and the Middle East go from a relationship of mutual dependency as consumer and supplier to adversaries battling for the same markets.

Q. With oil prices expected to remain low for a long time ahead, do you think India's strategy to invest in alternative energy makes sense?

A. As a country with fast-growing energy needs and increasing dependency on oil and gas imports, it is absolutely essential for India to develop renewable sources of energy as well as to work towards energy efficiency and energy conservation. Prudent energy security and environmental protection policies should look beyond the day-to-day rise and fall of oil prices. While fossil fuels are expected to continue dominating the world's energy mix for a long time, increasing the share of renewables can serve as a natural hedge against future oil and gas price spikes.

Q. Do you agree this to be a start of a new multi-year or even a decade bear market for oil?

A. I am not sure I would call it a bear cycle, but yes, thanks to the US shale boom, we could very well see the new "equilibrium" price settle in the sub-$100 zone in the medium term, barring any major and sustained supply outages in the MENA [Middle East and North Africa] region producers.