Global Oil Supply

Why is supply not falling even as crude prices are crashing?

Basic economics teaches us the direct relationship between price and supply. At higher prices, supply tends to increase and at lower prices supply tends to automatically go down. This economic rule tends to hold, especially for commodities. Then why is oil continuing to behave in an anomalous fashion? Why does oil supply show no signs of faltering even as prices have been down over 50% in the last one year? Actually, there is a method to this madness. Here is why!

OPEC may not really matter…

For the Middle East (read Saudi Arabia), the OPEC was the fulcrum to exercise control over oil prices. That worked as long as the OPEC exercised substantial control over oil supply. Today the US and Russia produce almost as much oil as Saudi Arabia and both are not part of the OPEC. Saudi Arabia realizes that at this juncture the focus should be on maintaining market share rather than trying to prop up prices. The global oil market has been facing oversupply for over a year now and there are no signs of the situation changing.

New players are emerging…

Even within the OPEC, the control over oil supply is not entirely in the hands of Saudi Arabia. Other oil producing nations are willing to be a lot more flexible with oil consumers. Take the case of Nigeria and Angola; both part of the OPEC. Both Nigeria and Angola have agreed to spot pricing of crude oil. This means that buyers do not get tied down to long-term price contracts in oil. This makes a lot of sense at a time when prices of crude oil are weak and are likely to remain weak. This aggression from smaller partners has meant that Nigeria has become the largest supplier of crude oil to key countries like India.

Shia oil threat from Iran…

Saudi Arabia, a Sunni stronghold, does not want to cede oil leadership to Iran, a Shia state. With sanctions likely to be withdrawn on Iran, their oil could soon flood the markets. Saudi Arabia does not want to be in a situation where it loses out market share to Iran.

The US is innovating on oil…

If you want to know how US maintains peak supply at such low prices, the answer is innovation. The US shale producers have come up with techniques that can inject a greater density of sand into shale wells to increase output from the same well. This brings costs down to a level where US shale can make money at lower crude prices. For shale companies, idling is not exactly an option since they have capital employed and high cost debts to service. This innovation in shale drilling is, perhaps, one of the key reasons why oil supply is high despite low prices. That answers the anomaly of oil! ©

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