reuters analysis 2014 oil crash

7/23/2019 Reuters Analysis 2014 Oil Crash

1/19

A Brief History

of The Oil Crash


2/19

2 A brief history of the oil crash

Just three days earlier, benchmark Brent peaked at almost $116 per barrel, the

highest level for 2014, before beginning a relentless slide that would see prices

sink by more than 60 percent over the next seven months.

The reopening of Libyas ports and oilfields, which had been closed for months by

unrest, marked the oil markets tipping point.

Libyas production, which had dropped to 250,000 barrels per day (bpd) in April,

May and June from around 1.8 million bpd before the countrys civil war in 2011,

rebounded to almost 900,000 bpd over the next three months.

The increase was significant, but not because of the volume. World production and

consumption of oil are around 93 million bpd so the extra 600,000 bpd amounted

to less than 1 percent of daily demand. The resumption of Libyan exports mattered

because it was so unexpected.

On June 22 last year, two tankers loaded 1.3 millionbarrels of crude at the port of Tobruk in eastern

Libya and signalled the end of a decade-long boomin oil markets.

Firefighters work to put out the fire of a storage oil tank at the port of Es Sider in Ras Lanuf December 29, 2014. Oil tanks at Es Sider

have been on fire for days after a rocket hit one of them, destroying more than two days of Libyan production, officials said on Sunday.

REUTERS

Libyas production,which had dropped

to 250,000 bpd

rebounded toalmost 900,000

bpd over the nextthree months.


3/19


Two weeks earlier, Libyas crude exports had been seen potentially falling to zero

within days as the authorities struggled to contain a wave of protests paralysing

oilfields and ports across the country.

Expecting more unrest, hedge funds and other financial investors had amassed

a record long position in crude-linked futures and options positions equivalent to

650 million barrels of oil in order to bet on further price rises.

With Libya descending into chaos, Syria locked in a civil war of its own and

Islamist fighters racing across northern Iraq to threaten that countrys oilfields,

fund managers were anticipating a further loss of oil supplies, and it seemed the

nearest thing to a sure bet.

Instead, the Islamists failed to capture Iraqs key producing areas and Libyas

output began rising, catching investors long and wrong in the paper markets,and scrambling to turn around their positions.

By the beginning of September, fund managers had slashed their net position

in Brent- and WTI-linked derivatives by 60 percent, the equivalent of more than

400 million barrels.

Amid this massive liquidation of positions, Brent fell more than $13 per barrel,

or 11 percent, to the lowest level seen in over a year.

Much more was to come. Brent dropped to $86 per barrel at the end of October,

$70 by the end of November, $57 by the end of December and less than $47 on

Jan. 13, 2015.

0

100

200

300

400

500

600

700

0

20

40

60

80

100

120

140

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Hedge fund positions in Brent and WTI futures and options (million bbl) (left axis)

Brent oil price (1st month futures) (US$/bbl) (right axis)

WTI oil price (1st month futures) (US$/bbl) (right axis)

HEDGE FUND POSITIONS AND OIL PRICES DURING THE COURSE OF 2014

Sources: CFTC, ICE Futures Europe, Thomson Reuters Eikon

Brent dropped to

$86 per barrel atthe end of October,

$70 by the end of

November, $57 by

the end of December

and less than $47

on Jan. 13, 2015.


4/19


The spectacular slide in prices was comparable to previous slumps in 1985-86,

1997-98, 2000-01 and 2008-09.

The price drop has plunged the industry into crisis, with major international oil

companies and small independents cancelling billions of dollars worth of projects

planned for 2015 and 2016.

Among them, Schlumberger, the worlds leading oilfield services company, is axing

9,000 jobs (7 percent of its worldwide workforce) as exploration and production slow.

Seeking to conserve cash, the heavily indebted shale drillers at the heart of the

U.S. energy revolution have raced to idle rigs and lay off crews.

But if the resumption of Libyan oil exports served as the immediate trigger for the

price plunge, the seeds were sown years earlier at the height of the boom.

Smoke rises from an oil tank fire in Es Sider port December 26, 2014. A fire at an oil storage tank at Libyas Es Sider port has spread to two more

tanks after a rocket hit the countrys biggest terminal during clashes between forces allied to competing governments, officials said on Friday.

REUTERS

Two weeks earlier,

Libyas crude exports

had been seen

potentially falling to

zero within days as the

authorities struggled

to contain a wave of

protests paralysing

oilfields and ports

across the country.


5/19


In 2005, spooked by a rise in oil prices to $55 per barrel, from less than $20 at theend of the 20th century, U.S. legislators approved the Energy Policy Act.

The legislation, which passed with substantial support from both Republicans and

Democrats, instructed fuel distributors to begin blending increasing amounts of

ethanol into the gasoline supply.

In 2007, responding to a further increase in oil prices to around $70, Congress

passed the Energy Independence and Security Act, which stiffened the blending

targets even further and raised fuel-economy standards for vehicles sold in the

United States.

Those acts formed part of a raft of laws and government regulations introduced

in the United States and other advanced economies between 2004 and 2014to promote energy conservation and reduce demand for increasingly expensive

imported oil.

In the meantime, the soaring cost of gasoline, diesel and jet fuel encouraged

motorists, truck operators and airlines worldwide to reduce fuel consumption.

The number and length of discretionary car journeys began to fall, consumers

bought smaller and increasingly fuel-efficient vehicles, trucking companies

rationalised deliveries, airlines revamped their networks and removed excess

weight from aircraft.

Demand destruction

In the meantime,the soaring cost of

gasoline, diesel and

jet fuel encouraged

motorists, truck

operators and airlines

to do everything

possible to reduce

fuel consumption.

Men work on the rig of an oil drilling pump site

in McKenzie County outside of Williston, North

Dakota March 12, 2013.

REUTERS/Shannon Stapleton


6/19


Compressed or liquefied natural gas became increasingly popular as a cheaper

alternative fuel for transit buses, refuse trucks and some trucking fleets. North

American railroad operators revived long-dormant plans to convert locomotives to

run on a mix of natural gas and diesel, though none has yet made the change.

In retrospect, 2005 proved to be the peak year for oil consumption in the United

States and other advanced economies.

U.S. consumption of motor gasoline, diesel, jet fuel and other refined products

declined by more than 2 million barrels per day, almost 12 percent, between 2005

and 2013, even though the country s population increased by more than 20 million

over the same period and real economic output grew by 10 percent.

It was the biggest drop in fuel demand in history and mirrored around the

industrialised world. On one estimate, the advanced economies fuel consumption

in 2013 was 8 million bpd below what would have been predicted had the pre-

2005 trend continued.

Since 2005, fuel conservation has saved the equivalent of the entire exports of

Saudi Arabia, the worlds largest oil exporter.

Demand destruction in the United States, Europe and Japan provided room for

the rapidly developing economies of China, Southeast Asia, Latin America and the

Middle East to increase their own fuel consumption without pushing up prices.

But in Asia, too, there were signs in 2014 of lower consumption growth in response

to the pressure for greater efficiency and a general slowdown across the region.

A tank truck exits from the main gate of the Zawiya refinery and oil port towards the local market, December 18, 2013. Libya is stepping up fuel imports, with four

tankers queuing at one port as the OPEC producers second-largest refinery is running at only half its capacity due to oilfield strikes, a senior official said.

REUTERS/Ismail Zitouny

Since 2005, fuel

conservation has

saved the equivalentof the entire exports

of Saudi Arabia,

the worlds largest

oil exporter.


7/19


High prices did more than just restrain demand. They were the key catalyst for theU.S. shale boom, which resulted in the fastest growth in oil production in history

during 2013 and 2014.

The shale revolution stems from the successful application of horizontal drilling

and hydraulic fracturing techniques to particularly dense, impermeable rock

formations that proved resistant to conventional, vertical drilling.

Neither technique was new to the oil industry the first horizontal well was drilled

in 1929 and the idea of fracturing rock formations to stimulate oil recovery has

been around since the 1860s.

In the 19th century, fracturing was carried out with dynamite, but the industry

switched to acid in the 1930s, napalm in the 1940s and water mixed withchemicals in the 1950s and 1960s.

The problem has always been the relatively high cost of horizontal drilling and

fracturing. Both techniques were used extensively in North Dakotas Bakken shale

in the early 1990s but could not be made to work commercially, leading to their

abandonment by the end of the decade.

Shale revolution

In 2005, fewer than

150 oil wells were

drilled in the state

of North Dakota.The number soared to

850 by 2010 and more

than 2,000 in 2013.

An oil drilling rig is seen outside of Tioga, North Dakota, March 12, 2013.

REUTERS/Shannon Stapleton


8/19


However, a quadrupling of oil prices between 2002 and 2012

coupled with significant technological improvements in

steering equipment down wells and taking measurements

remotely created conditions for a second shale revolution,

and this time it did not stall.

In 2005, fewer than 150 oil wells were drilled in the state of

North Dakota. The number soared to 850 by 2010 and morethan 2,000 in 2013.

Almost all the new wells were drilled into the Bakken

formation - two layers of rich, black marine shale found

thousands of metres below the northwestern corner of the

state as well as beneath parts of neighbouring Montana and

Saskatchewan.

Bakken production surged from 2,500 bpd in 2005 to

250,000 bpd in 2010 and more than 750,000 bpd in 2013.

By the end of 2014, Bakken output had reached more than 1.1

million barrels per day.Horizontal drilling and hydraulic fracturing to target crude

spread to Texas from around 2010, first to the Eagle Ford

formation in the southwest corner of the state, then to the

Permian Basin in the west, which already had a long history

of conventional oil production.

Smaller production increases have come from fracking in

Oklahoma, Colorado, Utah and New Mexico. Texas and

North Dakota, however, account for 95 percent of the rise in

U.S. oil output since 2008.

The result has been an extraordinary renaissance in U.S. oil

production. Output surged from 5 million bpd in 2008 to

an average of more than 8.5 million bpd in 2014, and stood

above 9 million bpd at the start of 2015.

Production growth has been accelerating as shale drillers

become more efficient at locating wells and drilling

them faster.

Output increased by 160,000 bpd in 2011, 850,000 bpd

in 2012, 950,000 bpd in 2013 and 1.2 million bpd in 2014,

according to the U.S. Energy Information Administration.

Production increases were accelerating right through the

summer and early autumn of 2014 as shale firms drilled a

record number of super-productive wells into the Bakken,

Eagle Ford and Permian Basin.

Bakken production increased by an extraordinary 260,000

bpd by October 2014 compared with December 2013, while

combined output from the Eagle Ford and Permian Basinwas up by another 400,000 bpd.

Elsewhere in the world, high prices also stimulated record

investment in exploration and production in new, more

challenging areas, ranging from the Caspian Sea and deep

waters off the coasts of Latin America and West Africa to the

Arctic and East Africa.

So much extra crude has come from shale and other sources

that oil prices continued to fall throughout the last three

months of 2014 and into the first weeks of 2015 even as

Libyan supplies experienced new interruptions.

0

200000

400000

600000

800000

1000000

1200000

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

DAILY OIL PRODUCTION FROM NORTH DAKOTAS BAKKEN SHALE (BARRELS)

Source: North Dakota Department of Mineral Resources


9/19


By 2012 or 2013 at the latest, the global oil market was on an unsustainabletrajectory with stagnating fuel demand meeting rapidly increasing supply.

The only solution was a sharp fall in prices, which had been above $100 per barrel,

to curb demand destruction and reduce investment in new sources of production.

But the need for lower prices was masked by two factors. First, many observers

doubted the shale revolution could last. Second, increased output from North

America was offset almost exactly by a loss of production across the Middle East and

Africa as a result of war, unrest and sanctions in Libya, Syria, South Sudan and Iran.

In its 2011 World Oil Outlook, the Organization of the Petroleum Exporting

Countries (OPEC) concluded that shale oil should not be viewed as anything other

than a source of marginal additions to crude oil supply.

The producer group went on: Significant constraints over the next ten years

include: the need for geological analysis of other shales; trained people to

perform hydraulic fracturing; and acquiring the horizontal drilling and fracturing

equipment. In the U.S. already, costs have accelerated sharply as the demand for

fracking equipment cannot be met.

Looking ahead, it is evident that output from new shale oil deposits will not grow

at a similar rate of 60,000 b/d per year as the Bakken basin is presently, OPEC

concluded, in what must be one of the most spectacularly inaccurate forecasts of

the shale boom.

OPEC was not alone in being deeply sceptical about shales sustainability. Many oil

analysts and non-shale producers shared its stance.

By 2013, however, that position was no longer tenable as shale production

continued to accelerate. OPECs 2012 World Oil Outlookacknowledged shale oil

represents a large change to the supply picture and the scale of that shift has

become more obvious over the last two years.

Supply disruptions

OPEC was not alonein being deeply

sceptical about shales

sustainability. Many

oil analysts and

non-shale producers

shared its stance.

A camel rests at a fuel station in the Judean desert near the West Bank city of Jericho January 11, 2015.

REUTERS/Baz Ratner


10/19


With so much new crude coming from U.S. shale, the preservation of balance

in the oil market required ever-increasing supply disruptions from conventional

producers in the Middle East, North Africa and other parts of the world, as well as

continued demand growth from China, Southeast Asia and the Middle East.

Until the middle of 2014, it seemed that unplanned outages might offset thecontinued rise in shale production.

Growing turmoil in the wake of the Arab revolutions that started in 2011 had

almost eliminated Libyan oil exports.

With Islamist fighters surging across northern Iraq and capturing the city of Mosul

in June 2014, many oil experts became alarmed at the threat to the countrys

northern oilfields around Kirkuk and Kurdistan as well as potentially the much

larger fields in the south of the country.

Some even began to worry about external or internal threats to political stability

and oil production in the Gulf monarchies.

The perception of intensifying geopolitical risks to oil supplies encouraged hedge

funds and other speculators to amass a record bullish position in crude-linked

derivative contracts.

But from late June, it became increasingly clear that geopolitics would not further

interrupt the supply of crude. Oil continued to flow from all parts of Iraq and

increase from Libya.

Robbed of the last remaining source of support, the incipient oversupply in the

market became increasingly obvious and a sharp price correction inevitable.

0

2

4

6

8

10

1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2 005 2010

U.S. OIL PRODUCTION SINCE 1920 (MILLIONS OF BARRELS PER DAY)

Source: US Energy Information Administration

The perception

of intensifying

geopolitical risks

to oil suppliesencouraged hedge

funds and other

speculators to amass

a record bullish

position in crude-

linked derivative

contracts.


11/19


Senior policymakers in Saudi Arabia appear to have graspedthe inevitability of lower prices faster than many investors.

Throughout September, October and November 2014,

speculation intensified about possible production cuts by

OPEC members, led by Saudi Arabia.

The Saudis downplayed the prospect. In early October, senior

Saudi officials began to brief analysts and traders not to

expect output reductions and indicated the kingdom was

prepared to watch prices slide.

Cutting production to keep prices artificially high would

only sacrifice Saudi Arabias and OPECs market share andallow shale production to continue expanding. Instead, the

kingdom determined to let prices decline enough to begin

curbing investment in new shale wells and formations.

Policymakers remembered bitter lessons from the early

1980s, when Saudi Arabia cut its production and exports

to prop up prices in the face of falling demand and rising

supplies from non-OPEC producers including the North Sea,

Mexico, China, the United States and the Soviet Union.

In the end, the kingdom suffered a double hit to its revenues

from lower prices and reduced output. Saudi policymakerstoday are determined not to make the same mistake.

On Nov. 27, 2014, OPEC announced that it would maintainits combined production at 30 million bpd. Brent, which

had already fallen to $77 per barrel by the time of the OPEC

meeting, dropped another quarter to $59 over the next

month as the market digested the fact that the group would

not come to the rescue.

The current price slump is often portrayed as a straight fight

between Saudi Arabia and the North American shale drillers,

but the real picture is more complicated. Shales impact on

the oil market has been so disruptive because it emerged

right in the middle of the cost curve.

Breakeven prices for shale wells range from as low as $30 per

barrel to $75 or above. Shale production is more expensive

than tapping conventional fields on the Arabian peninsula

but cheaper than some megaprojects such as Kashagan in

the Caspian Sea. Its breakeven range overlaps with high-

cost oil from stripper wells, oil sands, heavy oil projects,

ultra-deepwater and Arctic projects as well as aging fields

including those in the North Sea.

As a result, Canadas oil sands producers, North Sea firms,

ultra-deepwater drillers, heavy-oil promoters and shale drillers

outside North America have found themselves caught in thecrossfire between Saudi Arabia and its closest OPEC allies on

the one hand and U.S. shale entrepreneurs on the other.

Price war begins

Saudis Oil Minister Ali al-Naimi arrives at Emirates palace to attend the OPEC meeting in Abu Dhabi December 3, 2007.

REUTERS/Ahmed Jadallah


12/19


Oil prices must ultimately drop to a point at which the market rebalances - whichmeans eliminating some of the previously forecast production growth and slowing

or reversing the loss of demand.

There are signs the adjustment is well under way. U.S. motorists have begun to

buy bigger cars again as low prices reduce the emphasis on distance per gallon in

favour of space and performance.

Large and small oil companies have cut tens of billions of dollars from their

exploration and production budgets for 2015 and 2016.

In the shale patch, producers have slashed drilling programmes for 2015 and

started to idle rigs, conducting layoffs.

Between early October 2014 and Jan. 9, 2015, almost 190 rigs previously drilling

for oil in the United States were idled around 12 percent of the total. In all, 550

rigs could be deactivated in the coming months.

It will take time for the slowdown in drilling to filter through to a slowdown in

supply growth because of a large backlog of shale wells drilled in 2014 that have

not yet been completed. As these enter production, supply will continue to grow

for a few months more.

But output from existing wells is not stable. After a burst of high production in the

first few months after a shale wells completion, output tapers rapidly as natural

underground pressure wanes. Production from Bakken wells declines as much as

two-thirds by the end of the first year.

Painful adjustment

Large and small oilcompanies have cut

tens of billions of

dollars from their

exploration and

production budgets

for 2015 and 2016.

Saudi Arabias King Salman is seen during U.S. President Barack Obamas visit to Erga Palace in Riyadh

January 27, 2015. Obama sought to cement ties with Saudi Arabia as he came to pay his respects on

Tuesday after the death of King Abdullah, a trip that underscores the importance of a U.S.-Saudi alliance

that extends beyond oil interests to regional security.

REUTERS/Jim Bourg


13/19


New wells must constantly be drilled and fractured to replace the falling output

from old ones. Unless oil prices are high enough to cover the associated costs,

drilling will stop, denting shale output.

Estimates of breakeven costs vary, but many sources suggest oil prices have fallen

beneath the threshold needed to maintain current output levels.

North Dakotas state oil regulator has forecast output to decline several hundred

thousand barrels per day by the middle of 2015, and even more in 2016, unlessprices recover.

The Energy Information Administration sees U.S. output growing by another

300,000 bpd to a peak of almost 9.5 million bpd in May 2015, then falling

between June and September on a lack of new drilling and as well rates decline.

Beyond September, the EIA expects U.S. oil output to start growing again but that

is based on an assumption that prices will recover to around $70 by the end of

2015 and edge up further in 2016.

Saudi Arabia and the United Arab Emirates have made clear they will not cut

production unless shale producers also restrain output, and perhaps not

even then.

The Gulf monarchies amassed large financial reserves during the boom and are

now indicating that they are prepared to run budget deficits for a year or two to

wait out the shale players.

What happens to production and prices in 2015 therefore largely depends on the

responses of the shale companies how far they cut drilling and production, how

far they can improve efficiency and cut costs to reduce the breakeven price for new

wells while sustaining production in an environment of lower prices.

.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

ESTIMATED OIL SUPPLY INTERRUPTIONS WORLDWIDE (EIA) (MILLIONS OF BARRELS PER DAY)

Source: US Energy Information Administration

Saudi Arabia and the

United Arab Emirates

have made clear theywill not cut production

unless shale producers

also restrain output,

and perhaps not

even then.


14/19


Saudi Arabia responded to the rise of U.S. shale oil and other non-OPEC oil sources,

which threatened to push it out of markets such as the United States, by abandoning

a decades-old policy: instead of cutting production to support prices, it allowed prices

to slide in order to eliminate higher-cost producers. This strategy has left it in a test

of wills it needs to withstand the pain of low oil prices longer than the high-cost

producers can stay in business. The battle could take several years, but the signs are

that Saudi Arabia can win.

The government relies on oil export revenues for about 90 percent of its income, so

low oil prices are doing serious damage to its budget. In December the government

projected a record budget deficit of $38.7 billion for 2015, over 5 percent of gross

domestic product; analysts estimate the budget assumed an average oil price of

about $60 per barrel, so if oil stays around $50, the deficit will be even bigger. Some

energy and petrochemical projects are being put on hold because they no longer look

economic. National oil giant Saudi Aramco said it would postpone a number of projects

and seek to renegotiate some contracts sources told Reuters that a $2 billion plan to

build a clean-fuels plant at Ras Tanura had been suspended.

But cheap oil will not necessarily mean a sharp economic slowdown, because the

government has the financial resources, built up over years of sky-high oil prices, to

keep spending. Finance Minister Ibrahim Alassaf has declared Saudi Arabia will runa counter-cyclical fiscal policy, using its reserves to maintain heavy expenditure on

infrastructure and welfare projects in order to offset any negative impact from cheap

oil. As a result, gross domestic product is expected to grow by 3.2 percent this year, a

Reuters poll of analysts found in January, down only moderately from an estimated

3.95 percent last year.

Saudi Arabia is likely to liquidate tens of billions of dollars worth of foreign assets,

mainly U.S. securities and bank deposits, to fund its strategy this year. But the numbers

suggest it has the money to stay the course for at least several years; government

reserves at the central bank total $241 billion, while the central bank had the

equivalent of $732 billion of net foreign assets in November, including $545 billion of

securities and $131 billion of deposits with banks abroad. That excludes other assets

and the ability of the state, which has miniscule debt, to borrow.

National oil giant

Saudi Aramco said

it would postpone

a number of

projects and seek to

renegotiate some

contracts sources

told Reuters that a$2 billion plan to build

a clean-fuels plant at

Ras Tanura had been

suspended.

Saudi Arabia

Country Profiles


15/19


The halving of global oil prices since last summer has thrown Russia into a full-blown

economic crisis. Long dubbed the lifeblood of the Russian economy, oil revenues are

critical both for export earnings and for funding government expenditures.

While President Vladimir Putin and his officials have long bemoaned their countrys

excessive reliance on natural resources, the 15 years of Putins rule have seen no export

diversification. Russias dependence on commodity prices has actually risen, reflected in

the rising oil price needed to balance the national budget.

Oil and gas account for around 70 percent of Russias exports, of which about four-fifths

come from crude oil or petroleum products and the rest from natural gas (the price of

which is linked to oil). A rough rule of thumb is that every $1 fall in the oil price reduces

Russias annual export earnings by $3 billion. This in turn means that if oil prices stay at

their present $50 per barrel for a year, Russia will earn around $150 billion less in 2015

than in 2014 equivalent to more than 10 percent of its gross domestic product.

Despite this slump in export earnings, forecasters expect the current-account surplus to

remain positive in 2015. The burden of adjustment is shouldered by the rouble, which has

lost almost half of its value against the dollar since the middle of last year. This devaluation

is expected to cut Russias imports in half, as pricey foreign goods deter buyers and

make consumers poorer. While this helps to keep the external accounts in balance, the

adjustment is far from painless.

Rising import prices mean inflation almost doubled last year to 11.4 percent, and it

continues to increase: forecasters expect it to exceed 15 percent by the spring, with some

predicting that it will still be in double digits by the year-end.

Adding to the economic problems is the effect of sinking oil prices on investor confidence.

Net capital outflows reached $150 billion in 2014 and are officially forecast to be around

$120 billion this year. While these massive net outflows largely reflect a freeze on Western

bank lending, caused by sanctions imposed because of Russias actions in Ukraine, the

outflows have accelerated as oil prices and the rouble plunged.

Faced with the sliding rouble, surging inflation and huge capital outflows, the central bank

has raised its main lending rate to 17 percent, including an emergency 6.5-point hike in

mid-December. The combination of tight money, slumping exports, rising inflation and

sinking investor confidence is pushing Russia into recession. The International Monetary

Fund forecasts the economy will contract by 3 percent this year, while credit-rating agency

Moodys forecasts a 5.5 percent slump. Many forecasters also expect the economy to

continue to shrink next year.

A separate set of worries concerns the governments budget, which relied on oil and gas

taxes for around half of revenues. Russia has steadily ramped up government spending

over recent years, and as a result the break-even oil price for the federal budget has risen

from below $40 per barrel in 2007 to over $100 per barrel last year.

The weaker rouble provides some compensation for the effect of lower oil prices on the

budget, reducing the break-even price to around $80 per barrel now. Even so, Finance

Minister Anton Siluanov has said that at $50 per barrel the budget would face a 3 trillion

rouble ($45 billion) shortfall this year. This may well be an underestimate, as Russia hastily

draws up emergency anti-crisis measures set to cost tens of billions of dollars.

Russia has some $90 billion in its Reserve Fund that could be used to plug budget holes

enough to cover the projected shortfall for about two years. The most critical question forRussia is therefore not how low the oil price goes, but how long it stays there.

Russia

A rough rule of

thumb is that every

$1 fall in the oil pricereduces Russias

annual export

earnings by

$3 billion.


16/19


In Canada, plunging oil prices have cost jobs, hammered government finances, forced

its central bank to shock the market with a rate cut and sliced into the profitability of

Albertas oil-sands projects.

With oil prices hovering near break-even levels after falling by more than half from

their June peaks, Suncor Energy Inc in January fired 1,000 employees and contractors

and slashed capital spending for this year, just two months after releasing a more

optimistic budget. Royal Dutch Shell Plc removed 300 positions at its oil-sands mining

operations. One oil well-drilling association warned 3,400 direct jobs could be at risk

with the number of rigs working in the field expected to drop 41 percent. They also said

another 19,500 indirect jobs could be lost after nearly every Canadian oil company

slashed capital spending to focus on surviving the storm.

It has been the industrys worst predicament since the 2008 financial crisis. After years

of growth, which pushed Canadian oil exports above 3 million barrels per day (bpd) for

the first time last year, an industry that had long worried that it could not find enough

workers to support its ambitions began thinking it might have too many.

The impacts have been far reaching in Western Canada, where the resource sector is

the biggest contributor to government coffers. Jim Prentice, the premier of Alberta, the

province whose oil sands are the largest single source of U.S. oil imports, warned that

low prices would cost the government C$10 billion ($8 billion) and lead to three years

of deficit budgets.

Other regions are also feeling the pinch. Newfoundland, which takes royalties from

offshore production in its surrounding waters, expects a deficit of nearly C$1 billion,

while Saskatchewan has also warned that lower oil prices will cut into its finances.

But the biggest impact from the energy drop may have been on the countrys monetary

policy. Bank of Canada head Steven Poloz shocked markets on Jan. 21 with a rate cut

that drove the Canadian dollar to a near six-year low, a blessing for an oil industry

whose costs are in Canadian dollars but whose product is sold for U.S. currency.

The federal government is also taking a hit. Finance Minister Joe Oliver, a relentless

promoter of the oil industry during three years as the countrys natural resources

minister, warned in early January that he would not release a budget until April

instead of the usual February or March because of the uncertain oil market, though

he has pledged Canada will have its first balanced budget in 2015-16 since the

financial crisis.

To be sure, even as prices tank, some major oil-sands producers are planning forgrowth. Though hemmed in by a lack of tidewater pipelines and discouraged by six

years of U.S. indecision on TransCanada Corps Keystone XL project, these producers

say planned expansions would be too costly to cancel or will pay off with an eventual

recovery in crude prices. Some producers also plan to boost output in the hope that

increased economies of scale will cut their cost per barrel.

Imperial Oil Ltd, the Canadian affiliate of ExxonMobil Corp, said on Jan. 19 that

operations had begun at a 40,000-bpd expansion of its Cold Lake oil-sands operations.

Imperial began pumping steam at its Nabiye project in early January, with full output

expected later this year, adding to the 145,000 bpd it already produces at the site.

Royal Dutch Shell Plc

removed 300 positions

at its oil-sands

mining operations.

One oil well-drilling

association warned

3,400 direct jobs could

be at risk with the

number of rigs working

in the field expected

to drop 41 percent.

Canada


17/19


Venezuela was already on the rocks in 2014: its economy was contracting, annual

inflation was running above 60 percent, and currency controls had triggered scarcity of

basic goods including food and medicine. The OPEC countrys economy was managing

to limp along thanks to oil, the source of 96 percent of Venezuelas export revenue.

So when oil prices started to tumble from the high-$90s, economists quickly forecast a

perfect storm for the South American nation.

Indeed, the fall of some 60 percent in oil prices since June comes at a disastrous

moment for the country, which sits on the worlds largest crude reserves. Venezuela is

flailing under the weight of economic controls, including distortionary exchange rates

and fixed prices for staple goods. The oil shock promises to worsen the crisis and foes

hope it will lead to the collapse of Venezuelas polarising socialist government.

For starters, it will crimp authorities ability to import food and goods, aggravating

chronic shortages. Long lines for food, now a common sight throughout Venezuela,

have already triggered isolated protests. They have also dragged down President

Nicolas Maduros popularity and set the stage for a ruling-party setback at this years

parliamentary elections. A popular local cartoonist depicted Maduro about to be

crushed by a barrel in free-fall. Indeed, the oil slump raises the spectre of social unrest

in the volatile post-Hugo Chavez era.

The rout has also heightened fears of a financial collapse in Venezuela. With the

country having to allocate close to $10 billion to service its foreign bonds each year for

the next two years, markets are now pricing the countrys debt at default levels on the

belief that Caracas will be unable to keep up with payments.

Maduro has rejected speculation of a default, but yields on the benchmark Global

2027 bond have spiked from around 11 percent in June to 28 percent in mid-January.

Weaker coffers also lessen Venezuelas ability to cover hefty arbitration awards for oil

nationalisations under Chavez. A decision is expected this year on the 2007 takeover of

ConocoPhillips assets, which could see the country forced to pay around $4 billion

or more.

The cash crunch will likely hinder investment in the countrys chronically underperforming

energy sector. Financially strapped state oil company PDVSA already subsidises

services as diverse as yoga classes in public parks and free health clinics. Investment

plans now may be watered down further to tend to pressing social and political needs.

That said, tight finances could also encourage PDVSA to be more pragmatic in its

operations and austere in its spending.

With Venezuelas self-styled socialist revolution experiencing its most challenging

times in 16 years, many are wondering whether oils tumble will prove the final nail in

the coffin. There will be no catastrophe or collapse here, Maduro vowed in October,

when oil prices had fallen to around $80 per barrel. But with prices having almost

halved since, a weak Maduro appears to lack the political clout to implement painful

austerity measures. Instead, he told parliament in January that God will provide

following the oil rout, striking a tone of resignation that echoed throughout Venezuela.

Indeed, the fall of some

60 percent in oil prices

since June comes at a

disastrous moment for

the country, which sits

on the worlds largest

crude reserves.

Venezuela


18/19


In December 2014, Chinas monthly imports of crude reached 7 million barrels per day

(bpd) for the first time, signalling that the worlds largest energy consumer is as hungry

as ever for oil.

The Chinese government is taking advantage of falling prices to stockpile crude for its

strategic reserves, analysts say.

Chinas crude supply imports plus domestic production exceeded demand

from domestic refineries by almost 900,000 bpd in December, part of an implied

90-million-barrel surplus China built up over 2014, much of which would be destined

for the strategic reserves.

China is secretive about its reserves, although the government said in November that

the first of three phases was holding 91 million barrels. Estimates put the stockpiles atroughly 30 days of imports, still far short of the OECD-standard 90 days targeted

by China.

Stockpiles aside, crude runs in China have followed imports to new highs. The countrys

implied oil demand a combination of crude throughput and net imports of refined

products - continues to expand. The pace of growth is more modest than initially

forecast, however, amid an economic slowdown that saw growth last year at its slowest

since 1990. The International Energy Agency revised its estimate for oil demand growth

in 2014 from 3.6 percent down to 2.7, and from 4.2 percent to 2.5 in 2015.

Supported by a burgeoning car culture, implied demand in 2014 broke 10 million bpd,

even as diesel demand from industrial users has retrenched. State-run giant Sinopec

reported that its diesel production fell 4 percent, while gasoline production rose 12.5

percent in 2014. A roughly 50 percent increase in consumption taxes on fuel, though,

will temper demand growth.

Low prices have put pressure on Chinas three state oil giants, already under scrutiny

amid an anti-corruption campaign that has targeted, in particular, China National

Petroleum Corp (CNPC).

The campaign could dampen enthusiasm for overseas deals, like those in Canadas oil

sands, that could enhance Chinas long-term energy security. Unlike previous years,

when obviously acquisitions were seen as glamorous or something that you do to get a

promotion in the Communist Party, now people will look at you and say, why did you do

this? The first thing they think of is, because youre getting a kickback, one analyst said.

Domestic crude output from the worlds fourth-largest producer is a question mark,

with CNPC planning to cut output at Daqing by 11 million barrels in 2015, given high

oil-extraction costs at the aging field, Chinas most productive. Yet with slimmer profits

comes the incentive to produce more. December saw the highest levels of domestic

crude production since at least January 1999. Even so, domestic production stayed flat

in 2014, up just 0.5 percent.

At the pump, even the state oil giants are not shielded from the effects of lower global

prices; a regulatory scheme put into effect in 2013 links retail gasoline and diesel prices

with crude benchmarks, adjusted on a biweekly basis. But the bottom line has been

propped up by cuts to a windfall tax on crude oil, which will now kick in at $65 a barrel

instead of the previous $55.

Low prices have put

pressure on Chinas

three state oil giants,

already under scrutiny

amid an anti-corruption

campaign that has

targeted, in particular,

China National

Petroleum Corp

(CNPC).

China


19/19

AUTHORS

Jason Bush

Henning Gloystein

Scott HaggettDale Hudson

John Kemp

Adam Rose

Andrew Torchia

Alexandra Ulmer

Email [email protected]

Visit financial.thomsonreuters.com/energy

2015 Thomson Reuters. 1009375 02/15.

A worker prepares to fill a car at a gas station close to Copacabana beach in Rio de Janeiro, January 12, 2015.

REUTERS/Ricardo Moraes
mailto:energy%40thomsonreuters.com?subject=http://financial.thomsonreuters.com/energyhttp://financial.thomsonreuters.com/energymailto:energy%40thomsonreuters.com?subject=

reuters analysis 2014 oil crash

Documents