The Oil Price: Part 1

June 27, 2017

 

This title of this post is very straightforward and self-explanatory. However, the mechanics behind it, may be a little more complex. We’ve been hearing a lot lately “This happening because the price of oil low”, but do we really know what that means for us and why is it happening?

In Trinidad and Tobago, the energy sector accounts for roughly 40% of our Gross Domestic Product (GDP). 

 

The current prices of oil and natural gas stands at:

  • West Texas Intermediate Crude Oil = USD 43.51 per barrel

  • Brent Crude = USD 46.01 per barrel

  • Henry Hub Natural gas = USD 2.88 per MMBtu

NOTE WELL: THE PRICE OF OIL IS CLOSELY RELATED TO THE PRICE OF GAS (view graph below to see the trend)

 

What Drives the Oil/Gas Price?

 

1. Law of Supply and Demand

  • When the global supply of oil/gas exceeds the global demand, the price of oil/gas drops since there is now an excess of oil, with no one to buy it.

  • When the global demand of oil/gas exceeds the global supply, the price of oil/gas increases since there is now a “” in the supply, causing oil/gas to be in demand.

NOTE WELL: THE PRICE OF OIL AND GAS IS VERY SENSITIVE TO DEMAND AND SUPPLY

 

2. Geopolitics

Global politics in the form of countries’ interactions with one another influences the price as well.

For example, when the shale boom occurred in the United States and the U.S. transitioned from an importer to a producer of oil and gas, there was now an excess supply of oil (which was what the U.S. usually used). The Organization of Petroleum Exporting Countries (OPEC), whose objective is to co-ordinate and unify petroleum policies among its 14 member countries, decided to cut their production in the last quarter of 2016, to drive the oil price up. This caused tension between OPEC and the United States.

 

3. Strength of the US Dollar

There is an inverse relationship between the value of the U.S. dollar and commodity prices, i.e. dollar strengthens = drop in commodity prices. The U.S. dollar is the benchmark pricing mechanism for most commodities (including oil and gas) because the U.S. currency is the reserve currency of the world. It is viewed as the most stable currency in the world, since the U.S. economy is the strongest and most stable economy in the world. When the value of the U.S. dollar drops, foreign buyers will have more purchasing power as it takes less of their currencies to purchase one U.S. dollar

 

4. Weather

The demand for oil and gas (to be used as sources of energy) increases in winter and summer because in summer, more air conditioning units are used and in winter, more heating systems are used, thus increasing the global electricity demand which is fueled by fossil fuels.

 

Recent History of the Oil/Gas Price

 

As shown in the graph below, the two major recent falls in the oil price occurred in 2008 and 2014.

In 2008, there was a large spike in the oil price in the first half, followed by a massive drop.

In July 2008, the oil price peaked at around US $147.27 per barrel. Firstly, let us cover some reasons why there was a spike in the price: 

  1. There was a decrease in supply from Non-OPEC members, which resulted in a surge in global demand.

  2. In February 2008, Venezuela cut off sales to ExxonMobil (an energy company) stemming from a legal battle over nationalization of the company's assets in the country.

  3. Production of oil from the Iraqi fields did not recover from the damaged caused by war, and it was reported that in late March 2008, two main oil export pipelines in the south of Iraq were blown up, which cut the country's exports by 300 000 barrels of oil per day.

  4. Hurricanes Katrina and Rita hit the United States, causing major damages to infrastructure, thus contributing to a decrease in supply.

 

This now brings us to the fall in oil prices in the 2nd half of 2008, which took place against the Global Financial Crisis aka The Great Depression. This occurred due to:

  1.   Demand for oil dropped significantly globally due to the economic decline

  2. Decrease in demand since the prices were previously over US $100. If prices increase, demand will decrease.

  3. The Global Financial Crisis affected all the major "power players" or powerful global economies simultaneously, thus reducing their power and desire to import.

  4. In the United States, consumption fell by 1.8 million barrels per day or 8% causing their refineries to run at their slowest pace in 21 years.

  5. The US Dollar gained value which meant that the price of oil in dollars had to come down.

  6.  Talks of bailouts and rescue plans for companies caused the stock prices to tumble, which in turn caused the price of oil to fall as well. 

 

In the 2nd Quarter of 2014, the oil price fell significantly once more. Global supply of oil was more than the global demand, this was as a result of:

  1. Increased energy efficiency and a growing interest to switch from oil to other fuels.

  2. Unrest in Iraq and Libya (two massive oil producers).

  3. America transitioned from an oil importer to an oil producer. Even though it’s not an exporter, the amount it once imported significantly decreased, creating a decrease in demand and an excess of supply.

 

 

What does this mean for Trinidad?

Low oil/gas price coupled with low production output means one thing for the economy of Trinidad and Tobago, the energy sector would contribute less to the total revenues earned. As seen in the graph below, energy revenues peaked in 2014, and then began to decline, coinciding with the  fall in the oil price in late 2014.

 

It can be inferred that shocks to the oil price directly affects the economy of Trinidad and Tobago.

  • High oil/natural gas price = Economy doing good

  • Low oil/natural gas price = Economy doing bad

High oil/natural gas prices mean increased revenue for the country, whereas low oil/natural gas prices mean decreased revenue.

 

The Future, as a result…?

  1. OPEC will stick to their production cuts to drive the oil price up further. This was announced in May 2017.

  2. Many more companies within the Trinidad and Tobago energy sector will continue to undergo cuts, to cope with their loss of revenue from low oil prices.

  3. It is reported that by the year 2035, China may be the largest consumer of oil.

  4. In the 2030’s the USA may be self-sufficient in oil, due to their success with shale.

  5. There will be an increase in efforts to achieve decarbonization, as well as transition further towards renewable sources of energy.

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