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Jakarta Post

Analysis: 2016 oil price outlook: Flat or even lower

  • Adjie Harisandi

    The Jakarta Post

Jakarta   /   Wed, January 6, 2016   /  05:34 pm

World oil prices have dropped significantly since the end of 2014. In that year, the price of Brent crude reached a high of US$115.10 per barrel, with the average price for the year standing at $99.40 per barrel.

In contrast, in 2015 Brent crude achieved a high of just $67.80 per barrel, with the average price for the year standing at $53.60 per barrel. This figure indicates that the annual average crude oil price declined sharply in 2015, down 46 percent from the 2014 average. The downward trend of oil prices continues, as illustrated by the figure in December 2015 when the price touched $36.46, the lowest level since 2004.

Several reasons lie behind the oil price drop, which was not unexpected. Data released by the US Energy Information Administration (EIA) reveals that world oil production in 2014 consistently surpassed consumption for 11 months. The previous year'€™s data showed that global oil consumption in 2013 consistently exceeded production for nine months. Similar figures were also found in 2012 and 2011, where excess demand was found in both years.

According to the latest data, world oil supply outstripped consumption up to September 2015. This is expected to have continued for the remaining three months of 2015, as the oil price kept declining.

The additional oil supply is mainly coming from the US, which managed to ramp up production from a low of 7.06 million barrels per day in September 2005 to 15.2 million barrels per day in April 2015. Note that the increase in oil production in the US is due to the shale oil revolution. Meanwhile, OPEC members produced 37.91 million barrels per day in September 2015, which is not far from its peak production level during the 2004-2015 period.

Separately, OPEC '€” the world oil producers'€™ cartel '€” has generally refrained from playing a role in controlling prices. During this shale oil boom period, OPEC has chosen not to reduce its production. Meanwhile, in terms of world oil consumption, we are still seeing positive growth. However, this growth cannot keep pace with the growth in production resulting from the development of shale oil technologies. This has led to an oversupply. Moreover, world economic growth has also been unstable of late, resulting in slowing energy consumption in many sectors.

As the data clearly show that a global oil glut is the key reason why the oil price has continued to decrease in the last two years, OPEC has refused to reduce its production in order to control the price.

Going ahead, world oil prices are not projected to rebound to the $100 level, as was the case in the period from 2010 - 2013. The first point of attention is demand. It is worth noting firstly that many of the world'€™s major countries are expected to continue recording slow growth from 2015 - 2020 compared to that in the 2005 - 2008 period.

The IMF forecast of world economic growth projects that China'€™s economic growth '€” which has been a major driver of world economic growth '€” will continue slowing down from 2015 - 2020. Thus, economic growth will instead derive more from developed countries like the US and the EU. This means that world economic growth will be relatively gradual in comparison to the 2005 - 2008 rate of 4.8 percent on the back of China'€™s growth at the time of 12.0 percent.

The IMF projects that from 2015 - 2020, world economic growth will increase at an average of only 3.8 percent. This, of course, will have an adverse impact on world oil consumption growth, especially in comparison to the 2004 - 2008 period.

The second point worth noting is that investment in the oil industry is of a long-term nature, with current production resulting from investment decisions made five - 10 years back. This means that existing production capacity cannot simply adjust to price declines, by stopping production for example. The result is that oil supply is expected to remain relatively unchanged, thereby minimizing the possibility of any rapid price increases. Oil production will tend to hold firm or perhaps experience a natural decline despite the very profound price reductions and the fact that producers are operating in a loss-making environment. In the light of this, some decisions as to investing in increased production now and in the near future may be put on the backburner. So, we will not see an instant decrease in world oil production but it will adjust slowly.

Price outlook in 2016

In fundamental terms, technological developments for exploiting shale oil and gas have enabled an enhanced production of world oil, so that in effect declining oil prices cannot be avoided. However, at some stage the market is sure to find a new equilibrium when production increases at a higher rate than consumption.

With an increase in world oil production capacity from technological changes in US and a refusal to reduce production by OPEC, the oil price will tend to be flat or even lower. If we compare to 2015'€™s average level, the oil price in 2016, will be about $40 '€“ $50 per barrel. OPEC in the World Oil Outlook forecasts that the oil price will return to $70 per barrel in 2020, which means oil prices will be very slow to recover to their 2013 level.

But if we look at the history of trends in world oil prices, we see that the oil price is also very closely linked to political developments in oil-producing countries.

Of the world'€™s 10 major oil producers, five are located in the Middle East, namely Saudi Arabia, the UAE, Iran, Iraq and Kuwait. This major oil-producing region is considered prone to conflict. Since World War II, fluctuations in world oil prices have largely been brought about by the policies of Middle Eastern countries. Thus, it is expected that geopolitical factors may have some surprise effects on oil prices in the future, even as producers refrain from controlling production and prices remain depressed.

The writer is an industry analyst at Bank Mandiri

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