Energy Sector Price Rout Not Running on Empty



Price pain for energy producers likely to extend into 2016

In early December, oil prices hit their lowest levels since the end of 2008, when the Global Financial Crisis was severely undercutting risk asset prices and economic growth around the world. U.S. natural gas prices have fallen even more, plummeting to a 14-year low on December 14. Energy supply gluts have dovetailed with anemic demand amid a so-far mild northern hemisphere winter. Other factors are negatively impacting oil prices as well. Led by Saudi Arabia, the Organization of Petroleum Exporting Countries (OPEC) reaffirmed this month its year-ago decision to subordinate price to market share in a bid to drive out higher marginal-cost producers—mainly U.S. shale producers, which have proven resilient at cutting costs and producing more efficiently. Meanwhile, Iran's deputy oil minister has declared there's "absolutely no chance" the country will delay ramping up its oil exports, despite the low prices, thanks to the expected lifting in early 2016 of international sanctions on its nuclear program.



In its latest Oil Market Report, the International Energy Agency (IEA) forecasts 2016 oil demand growth of 1.2 million barrels a day (b/d). That's down from a peak of 2.2 million b/d in the third quarter of 2015 and an average annual demand growth for the year of 1.8 million b/d. As world consumption growth ebbs, global supply, led by OPEC, has continued to rise: November's 96.9 million b/d of global supply was 1.8 million b/d higher than a year ago. The bulk of that came from OPEC, as non-OPEC's annual supply growth dropped to less than 300,000 b/d last month from 2.2 million b/d at the start of the year. The IEA expects a decline of 600,000 b/d in non-OPEC output in 2016 as U.S. shale oil production contracts. OPEC's strategy of pricing higher-cost producers out of the market may finally begin to work.

Most industry forecasts for 2016 have supply growth again outstripping demand growth, suggesting the oil price pain should continue—for OPEC and non-OPEC producers alike. On top of the bleak price outlook, many oil producers are also increasingly worried about record oil inventories. Were stocks of oil to max out global storage capacity before demand picks up enough to absorb the growing supply, the price rout could easily accelerate from current levels. That may not materialize: In its December report, the IEA pointed to the continuing build in global oil inventories "at least until late 2016," and noted that "new and spare storage capacity should be able to accommodate the projected extra 300 million barrels of stocks." Indeed, U.S. oil inventories are just 70% full. That's about the only good news for producers in the IEA's report. For energy consumers globally, though, depressed oil prices are unambiguously positive.

The vast majority of countries around the world are net energy importers, including roughly 70% of emerging markets. Net oil exporters in the Middle East and Africa along with Russia, certainly suffer from low prices. But far more developing countries benefit from low energy prices, especially in Asia, where nearly all countries are net energy importers, including China, India and Indonesia, which have taken advantage of lower energy import bills to reduce domestic fuel subsidies and direct public spending to other priorities with higher social and investment returns.

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