On 8 September, the price of Brent crude oil fell below $100 a barrel for the first time in 14 months. The fall, which continued throughout the month, has left oil analysts scratching their heads over the outlook for oil prices in what appears to be a counter-intuitive decline.

Historically, the merest whiff of uncertainty regarding the Middle East’s energy supply has triggered a push to stockpile crude, leading to a spike in prices. On this occasion, however, despite much instability in the region, oil prices have not only dipped, but have fallen to levels not seen since early 2011. On 2 October, the barrel price stood at $92.3.

Ordinarily, the political crisis in Iraq caused by the insurgency of the Islamic State in Iraq and Syria (Isis), coupled with the ongoing Syrian civil war, would be more than enough to force oil prices high. But not this time.

Even Scotland’s independence referendum in the UK, the EU’s largest oil producer and the originator of the Brent benchmark, had only a minor impact on prices.

New factors

However, the drop in crude prices to below $95 has raised questions about what exactly is causing the downward pressure and what the implications are for the Middle East’s major oil producers, particularly members of the oil producers’ group Opec, who favour a ‘fair and even’ price of $100.

“Usually a major geopolitical event such as the US and its allies bombing Isis would trigger higher oil prices,” says Robin Mills, head of consulting at Dubai’s Manaar Energy. “However, this time it was not the case and other factors were deemed more important.”

Fundamentally, the macro-economic picture suggests supply is easily outpacing demand for oil. A host of disappointing economic data and other issues regarding global financial dynamics were revealed in mid-2014 in major economies such as the US, China, Japan and the eurozone countries of France, Germany and Italy.

Recovery in Japan and the eurozone economies remains slow, resulting in lower than expected demand for oil. But the US’ continued recovery is the key fiscal performance indicator that has caused downward momentum on the oil price.

The US Department of Commerce published a report in September that estimated second-quarter growth of 4.6 per cent in the US economy. The Dollar Index, which measures the performance of the US dollar against a basket of major international currencies, rose to a four-year high that month, triggered by Washington’s decision to end quantitative easing.

There is no question that, going forward, it is oversupply that poses the greatest risk to prices

Robin Mills, Manaar Energy

Due to all commodities being traded in US dollars, the value of the US dollar plays an important role in determining oil prices. The low value of the dollar prior to the global economic crisis was responsible for 51 per cent of the $97-a-barrel oil price increase between 2003 and 2008. If the dollar had held its 2001 value against the euro, the oil price spike in 2008 would have been $76 a barrel and not $147. The same is true in reverse. A stronger dollar will generally result in falling oil prices.

China slowdown

The growth being enjoyed by the US is in contrast to China’s sluggish progress in 2014. Several factors are undermining growth in the world’s second-largest economy, not least a slowing domestic housing market. China’s real estate sector has been cited as the greatest threat to the stability of the economy, with oversupply being the primary concern.

This was compounded in August, when Beijing announced industrial production growth of 6.9 per cent. This represents the lowest rise since 2008 and means the GDP growth forecast is about 7.5 per cent for 2014.

If anything, $100-a-barrel prices for crude have surpassed most of the major producers’ expectations and have confounded most analysts who predicted a sharper decline at an earlier date.

“There is no question that, going forward, it is oversupply that poses the greatest risk to prices,” says Mills. “When the price starts to drop below $90, it is very likely Opec members will take action and start cutting production.”

The only Opec member that can make any kind of difference is Saudi Arabia. Riyadh has already started to draw back on what was looking to be another record year for production by trimming 300,000 barrels a day (b/d) from its August output. It is likely to require far more drastic action to arrest the slide in oil prices.

Analysts say that only a cut of about 1 million b/d from Opec will make a significant difference and, although Kuwait and the UAE could pitch in, only Saudi Arabia can absorb such a major decline in a short timeframe. Due to sanctions, Iran is already producing about 1.5 million b/d below its production capacity and Iraq’s unique position means it is immune to quotas. Libya’s production has been extremely unpredictable over the past 12 months, and even domestically, it is unclear how much oil is being produced in the volatile North African state.

All of the major Gulf producers have anticipated lower oil revenues and have adjusted their budgets accordingly, and most also have high levels of government savings squirrelled away during the good times of the past three years. However, high break-even oil prices for many producers mean the region will still have to act if prices continue to fall.

The Washington-based IMF’s break-even oil price estimates across the Middle East are mostly much higher now than they were at the turn of the decade. This is due to increased spending on social infrastructure in an attempt to address the concerns of their populations, following the recent uprisings.

Saudi Arabia has the highest break-even price of $86.1 a barrel, up from $69 a barrel in 2010. This is low considering the billions of dollars Riyadh has lavished on government-led capital spending. Allowances have also been made for lower oil prices, with Riyadh stating savings will cushion the effect of any major decreases to enable spending to continue.

Qatar and the UAE both have a fiscal break-even point of $70-$75 a barrel, while Kuwait’s break-even price is $52.3.

Iran, Iraq, Bahrain, Algeria, Oman and Libya, however, require $100-plus prices to balance budgets and avert deficits. Libya is suffering the most, with a break-even price of $184.2, up $126.5 a barrel from the 2010 figure.

Looking towards the mid-term, the threat of oversupply both within Opec and from external producers such as the US and Russia means $80-$90 a barrel prices or lower could become the new norm.

The US’ non-conventional oil and gas production continues to confound analysts. Where talk of overtaking Saudi production figures seemed extremely fanciful in 2011, it is now looking likely.

The US is producing about 8.3 million b/d of crude, but this figure is expected to surpass both Saudi Arabia and Russia by the end of the decade, even sooner if liquid petroleum gases such as butane and propane are factored in.

Global oil supply has grown by 1.7 million b/d year-on-year up to the end of the third quarter of 2014. Non-Opec supply grew even more, by 1.8 million b/d. As prices begin to ease, all of the region’s producers have to accept that, barring any serious geopolitical incident, three-figure oil prices will ease to the $90 level over the next few years.

Short-term stability

In terms of oversupply, Iran’s continued exclusion from making significant oil exports means this issue will not come to a head for at least another year. Iran being allowed to export and Libya stabilising could represent up to an additional 2 million b/d of Opec supply. 

 On the flip side of this argument, the long-term viability of the US’ shale oil production is still uncertain, and while there is no denying the initial success, there has still been no concrete argument to suggest the sector can be sustained for two or three decades. The Middle East, in contrast, has well over half a century’s-worth of easy accessible oil remaining.

The challenge for the region is that governments that have made significant commitments to develop infrastructure and create jobs on $100-plus oil will have to adapt to lower revenues. For the region’s oil importers, however, especially those with high subsidies for fuel, the promise of cheaper access to oil will come as a sharp relief and maybe even go towards easing some of the tensions of the past three years.