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Collapse of the crude oil price
The dramatic collapse of the crude oil price at the end of 2014 caught the market unawares. Between February 2011 and August 2014, Brent crude oil traded in fairly stable price range, averaging US$110 per barrel (/bbl). The industry players came to accept US$100/bbl as an appropriate price for planning purposes.
The oil price is plummeting because there is an oversupply of crude oil in the market. Crude oil was predominantly produced from porous rocks, a process which involves drilling into them, extracting their contents and capturing them in subterranean reservoirs. The Organisation of Petroleum Exporting Companies (OPEC) currently produces approximately 40% of the world’s crude oil (30 million bbl/day) and the balance comes from various other countries. Large amounts of oil and gas are trapped in less porous shales. Fracking is the technology that is used to extract oil and gas from these shales. The Investopedia defines fracking as “the procedure of creating fractures in rocks and rock formations by injecting fluid into cracks to force them open. The larger fissures allow more oil and gas to flow out of the formation and into the wellbore, from where it can be extracted.” The United States had experienced a declining oil production for many years; however, thanks to fracking, production started to increase in 2009. According to the BP Review of World Energy June 2014, the US posted an increase in oil production from 6 783 million bbl/day in 2008 to 10 003 million bbl/day in 2013. The US is pumping shale oil at the fastest rate in more than 3 decades and this has led to an increase in global oil production. The situation is exacerbated because OPEC has engaged in a price war with the United States. This means it is now cheaper to pump oil out of places like Saudi Arabia and Kuwait, but more expensive to extract oil from places like Texas and North Dakota. This is done with the intent of taking market share from the United States. As the price of oil keeps plummeting, some US producers may just become unprofitable and go out of business.
Impact of lower oil prices on the global and local economy
Lower oil prices can result in collapsing capital expenditures, unemployment and a potential financial implosion. The last time the oil price plummeted by more than 40 dollars in less than 6 months was during the second half of 2008. This crash in price preceded the recession that happened later that year by a few months. According to Michael Snyder of The Economic Collapse, the stakes are even higher this time around. The dramatic decrease in the price of oil is an indication that economic activity is slowing down and is known to have a destabilizing effect on financial markets.
Energy companies account for approximately 20 percent of the junk bond market. Investing Answers defines a junk bond as a fixed-income security that is rated below investment grade by one or more of the major bond ratings agencies. It works the same way as most other bonds, where an investor purchases a bond from a bond issuer with the assumption that the money will be paid back when the bond reaches its maturity date. The difference between an investment grade bond and a junk bond is that the junk bond issuer may not be able to repay the original principal when the entity that is issuing the bond is facing financial trouble. The implosion of junk bonds is usually a good indicator of a looming major stock market crash.
The shale oil boom in the United States has resulted in the creation of millions of jobs since the last recession and it has contributed to the financial stability of the employed workforce. However, this boom will slow down in the second half of this year. In January 2015, thirty five horizontal rigs used to reach oil deposits in North Dakota and Texas, were idled and this was recorded as the biggest single-week drop since the drilling boom started six years ago. OPEC, which pumps almost approximately 40 percent of the world’s oil, has remained resolute in its decision not to curb production in order to abate the effects of the crashing oil price. Plummeting oil prices have resulted in a drop in the issuing of new well permits in the United States. According to Reuters only 4 520 new well permits were approved in November 2014 as opposed to 7 227 permits in October 2014. If the oil price continues to drop, unemployment will increase.
Funds used by a company to acquire or upgrade physical assets such as property, industrial buildings or equipment are known as capital expenditure. Companies make this outlay to maintain or increase the scope of their operations. Capital expenditure is good for the economy as it builds infrastructure and creates jobs. In recent years, energy companies have been investing a lot in capital expenditure with the belief that there are huge profits to be made. Unfortunately, these investments become unprofitable when the price of oil crashes. Internationally, ConocoPhillips has reduced its 2015 budget by 20 percent. Oil is the main source of revenue for Nigeria and the crashing price has forced the Nigerian government to halve capital expenditure for 2015. Oil companies are also bleeding. BP announced that their quarterly profits had fallen by 20% to $2.2bn in the last 3 months of 2014 due to crashing oil prices and this will be followed by curtailing capital expenditure. Closer to home, Sasol indicated that it would delay its $8.1bn investment in an ethane cracker in Louisiana, on response to low global oil prices and would identify other opportunities to cut costs over the next 30 months.
Impact of lower crude oil prices on the motorists in SA
The South African motorist has enjoyed the effects of the lower oil price and has had relief of just over R4 a litre in recent months. One would have expected a lower fuel price to encourage motorists to use their cars a lot more; however, this has not been the case. Edmund King of the AA said: ‘We were astonished that, when pump prices slumped in the last quarter of 2014, petrol demand remained weak. In 2012, demand ebbed and flowed with the price. According to the AA, this research confirms their suspicion that years of price spikes have left drivers scarred and sceptical. Since fuel is a daily essential, families, especially poor ones, find it hard to adjust to swings in the price of fuel.
On 4 February 2015, fuel prices decreased by 93.00 c/l for both 93 and 95 octane petrol. A motorist in Gauteng is currently paying R10.09/litre for 93 octane petrol and R10.31/l for 95 octane petrol until the price changes at midnight on 3 March 2015. Both grades of diesel (500 ppm and 50 ppm) decreased by R1.02 c/l on the wholesale price. This decrease followed lower oil prices due to oversupply in the market.
2015 Oil Price Forecast
Mike Schussler of economists.co.za, expects the international oil price to average around $60 – $65 for 2015. Oil prices are expected not to rise drastically as it will take some time for the oil that is in the over-supplied market to be used up. This means that the South African consumer will still be better off that when the petrol price was more than R14/l as recently as September last year.
The current under-recovery in the Basic Fuel Price (BFP) for the period 30/01/2015 to 13/02/2015 reflects a spike in the oil price to $60. Dawie Roodt, Chief Economist at the Efficient Group, says it is still early in the month to give a definite prediction on whether the fuel price will increase as this also depends on currency movements.
In its attempts to increase revenue, the South African Government may announce an increase in fuel levies and taxes later this month when the Minister of Finance Nhlanhla Nene tables his 2015 Budget Speech.