Wednesday, August 26, 2015

Oil now well below $40 per barrel | Supply war pits shale oil against traditional producers

The re-opening of the British embassy in Tehran over the weekend must have jolted the sensitivities of oil commodity traders the world over, as it provides a tangible reminder of the fact that more, rather than less, oil is destined for the world markets. The embassy opening is on the back of the recent western agreement with Iran that will, if and when finalised and ratified by all parties, allow it to begin exporting oil again. And apparently the country badly needs the revenue, even at current prices.

The precipitate fall in the black gold continues apace, for this and for a number of other reasons. The main one is a panic over the place that the Chinese economy occupies in terms of energy demand. Many years of doubtful and incomplete economic data out of China is exacerbating the current market panic and this is felt nowhere more than in oil prices. If $40 has been breached, what guarantees are there that $20 is not now on the horizon?

Supply war pits shale oil against traditional producers

None, is the answer. Demand is diminished and supply shows no sign of abating. Apart from Iran, shale oil producers in the US seem to be taking something of the same attitude to supply as the big iron ore miners in Australia and Brazil took recently in regard to their smaller competitors. In spite of falling prices they ramped up production, depending on their superior economies of scale to assist them in enlarging their market share – a euphemism for effectively driving smaller producers to the wall.

It is now suggested that, due to greater experience in shale oil extraction, improvements in technology and because of the completion and capitalization of more expensive early stage activities, the marginal cost of shale oil production is reaching that magic figure of $20 per barrel. This would allow shale oil companies to continue to produce, not to make profit, but to pressurize drillers in the Middle East. This, in turn, motivates Saudi Arabia and other countries to continue to pump oil, purely in order to maintain their position in the global markets.

From the point of view of western consumers, this is good news. For the traditional producers, things could get a lot worse before they get better.

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