THE STORY OF 2015: Delicate balance on the oil market
- Written by Laurentiu Rosoiu
The drop in oil prices is changing the economic face of the world as we knew it. It modifies the global flows of capital, it is reshaping the relationships between the oil and gas industry and the other sectors of economy and the relationships between consumers and companies, and it changes the balance of power between oil exporters’ economies and the net importers’ ones. The mutations in the economic field are therefore so deep and complex that, through its consequences, lead to the reconfiguration of the current global geopolitical status.
After the sharp fall during the second half of 2014, which culminated in reaching lows of the last five years in the first month of 2015, the month of February of the new year seems to have brought relative stability on the world oil market.
By mid-month the oil price was rising slightly, trading at around USD 50 per barrel for WTI crude and at USD 60 per barrel for Brent crude, i.e. about the same price levels as late last year. But the balance is still extremely fragile; a possible rebound in prices to the levels registered by mid 2014, i.e. before this wave of correction, is rather unlikely. This means that the transformation processes already printed on the financial and economic, as well as on the geopolitical architecture of the world, is irreversible. Indeed, most likely, the processes will continue at a higher pace than before.
This seems to be also the view of renowned economist Kenneth Rogoff, who was quoted by the news agency Bloomberg as saying earlier this year: “Oil prices are the big story for 2015. There are a once-in-a-generation shock and will have huge reverberations.”
THE FINANCIAL MARKETS
And the very first places where these reverberations of low oil prices are already seen are the financial markets. Developments on the stock exchanges are thus concomitantly the effects of falling oil prices and the reflections of the resetting process taking place in the oil and gas industry, offering therefore a first series of clues regarding the changes and transformations that the oil & gas industry will pass during the next period. As a result, the decreases in share prices of the oil and gas companies, on almost all world stock markets, are more than just a game of numbers on computer screens; they are above all an indicator that the oil and gas sector is no longer a destination for global capital flows. This is a mutation as obvious as it is important on the medium and long term, as it indicates the difficult access to finance for the profile companies.
Any potential project seeking funding will go through a more rigorous review process, conditions for granting will be stricter than before - in parallel with the fact that investors will be less interested in funding those companies on the stock market - this already looms as a new reality for the sector. Therefore, the cost for financing the projects in the oil and gas industry has all the prerequisites to follow an upward trend in the next period; this is reason for concern for the industry, as yields on investment projects in this area will evolve at a proportional rate, in a reversed trend.
Therefore the financial markets show that the oil and gas sector is already passing through an inauspicious period, which may continue long enough and will also accelerate the process of ‘resetting’ the industry on different basis.
THE OIL AND GAS INDUSTRY REPOSITIONING
Major changes in capital flows are already foreseeable within the industry, due to the repositioning of players in this field to the new realities.
For example, by the beginning of 2015 the British company BP (British Petroleum), one of the biggest players in the global industry, has announced it will reduce capital expenditures in 2015 by about 13 percent up to the level of USD 20 billion; the BP announcement came just a week after the US company Chevron, another giant in the oil and gas industry, had announced a cut in capital spending by 13 percent down to USD 35 billion throughout 2015.
The significant cut of investments the major players in the field anticipate is reflected by the reduced drilling activity. Thus, by the end of the first month of 2015, the number of drilling rigs globally operating for exploring new deposits or for the existing deposits development amounted to 3,309 units, by 200 units (or 7 percent) less than at the end of December 2014, and by 300 units (or 5 percent) less than in January 2014 (see the chart ‘Industry in decline’). The data, released by the American company Baker Hughes, one of the top three largest providers of services, products, technologies and systems for the oil and gas industry at global scale, complete the negative outlook for the oil and gas industry worldwide.
As for the United States, which can be considered a benchmark for the global profile industry, being the most active economy in the area of exploration of new deposits, figures describe an even wider activity decline: at the end of January 2015 in the US there were 1,683 rigs in operation, by 200 (or 11 percent) less than at the end of the previous month.
The downturn trend has all the prerequisites to continue, considering the estimates of any additional period of decline in oil prices and other official communications of major players in the industry - which shows exactly their intention of downsizing. An example is BHP (an Australian giant in the mining sector, having significant operations in shale oil and shale gas in the US), which informed at the beginning of the year about the public plan to halt no less than 40 percent of drilling operations in the shale fields by the end of fiscal year 2014 (end of July 2015).
The mutations in the oil and gas industry, or its relocation on other basis, are underlined by the figures and estimates regarding the development activities in the field of mergers and acquisitions. According to the latest report by the consulting company E&Y, the value of transactions in the oil and gas sector was of USD 443 billion in 2014, by 69 percent higher than in 2013. A clear indication that the industry is already resetting.
The trend is to continue the process, even at an accelerated pace, according to E&Y specialists. The value and number of M&A transactions will increase in 2015, they say, because the industry players will be increasingly under pressure to respond to challenges that can hardly be met otherwise. Thus, the industry faces a significant surplus capacity, with immense pressure given by the decreasing profit margins and a clear weakness of the stock markets. In such a context, E&Y analysts say, the sellers will be stimulated and consensus on transaction values will be easier to achieve. Mergers and acquisitions will have therefore a significant contribution to the process of remodelling the structure of the oil and gas industry worldwide as a result of falling oil prices.
OUTCOMES ON THE LABOUR MARKET
Beyond the relevance for industry players, the data revealing the reduction on engines speed in this sector provides also a measure of the impact of oil price decrease on the labour market. A lot of the top players in the industry have not only announced cuts of capital expenditure budgets, but also personnel restructuring, as shown in the table ‘Cost reductions and layoffs’.
In this context, a recent study conducted by a number of public and private associations in the UK shows that, due to lower oil prices, the oil and gas industry in the UK will lose some 35,000 jobs by 2019. In parallel, on the other side of the ocean, Dallas Federal Reserve Bank - one of the 12 member banks of the US system of Central Banks - has estimated that only the state of Texas will lose about 128,000 jobs in the oil and gas industry during 2015 if the oil price will remain at the level of USD 50 per barrel.
And even if the data and studies on the impact of falling oil prices on the world labour market are fewer, it is clear that the reducing of the giants’ activity in the field will propagate horizontally and vertically in all other ancillary industries, through local representations, to all the other areas of the world and to the personnel structure of all business partners.
CHANGES WITHIN THE ECONOMY
Therefore, the collapse of oil prices has already been felt, very quickly, on the labour market, inducing a first set of decisions to cut many jobs in the industry; the first and the most affected is the American economy. But this is just one of the visible effects that the fall in oil prices has sent to the economy, which will otherwise continue.
Another very important outcome of lower oil prices is that it lowers prices for other goods and services whose prices have as benchmark the oil prices - such as natural gas prices, which in turn determine the price of energy in general, and specifically the utilities, etc.
The mutations felt by the economy have a dual direction: first of all the companies operating in these areas will have lower revenues; the other side of the coin is that, due to lower oil prices, more money will remain in the consumers’ pockets. And, from an optimistic perspective, this can have the effect on the economy similar to a shot of adrenalin for humans, because this money can go into consumption, increasing the demand for other goods and services, thus stimulating other sectors of the economy.
According to an analysis conducted by the renowned publication ‘The Economist’ on the US market, an oil price of USD 50-60 per barrel will actually shift about USD 1,300 billion from the accounts of companies from the oil and gas industry into the pockets of American consumers.
According to these calculations, the typical American consumer - with average expenditures of about USD 3,000 for fuel supply in 2013 - will see in his pockets about USD 800 due to oil price decline, the equivalent to a salary increase of about 2 percent.
Such calculations are valid, maintaining the proportions and taking into account the specific differences, for almost all world economies, not only for the US. Moreover, even for the Romanian economy, where the cuts in fuel prices at the pump have been rather modest and only for a very short period of time, one can speak of a beneficial result; even though the effect was felt less in the pocket of the consumer, the fall in fuel prices has offered supplemental oxygen to transporters, who remained with more money in the accounts, thereby capitalizing more.
Apparently beneficial to the final consumer, the lower prices induced by the fall in oil prices maintain and even enhance the deflationary threat to the European Union economy in particular, but also to other developed economies in the world. Thus, according to forecasts made by the New York analysis department of the brokerage firm JP Morgan Securities, if oil prices remain below USD 60 per barrel in the first quarter this year, global inflation will record the lowest values since 2009 (when the global recession ended); more precisely, according to the JP Morgan analysts, in H1 this year the inflation rate will hardly reach 1.5 percent (only thanks to the emerging economies and to the highly inflationary economies!), and if the price of oil will continue to maintain at low levels, global inflation will fall to 1 percent.
In such a scenario, inflation in the Eurozone could go into negative territory - which actually means deflation - and the US, UK and Japan will reach the inflation rates of about 0.5 percent; this is a level that would bring them very close to the threshold of entering deflation. This outlook is not rosy for the global economy as the general price decrease (as deflation is defined) can have extremely negative consequences for the real economy as it inhibits investments and the development process. And this may result in GDP decline for the states facing this situation, which entails the diminishing of their budget revenues and thus question their ability to carry on their functions and duties.
Contemplating these threats, the central banks of the world’s major economies are likely to be forced to continue the low interests’ policy, to carry on liquidity infusion into the markets, which should stimulate economic recovery. Here there are nuances as well! Such an environment is rather stimulating for the economies importing oil, gas and/or energy in general. In contrast, the economies dependent on energy exports are not in very auspicious situation. Thus, countries such as Saudi Arabia or Kuwait, on the one hand, and Russia, Iran, Venezuela, on the other hand, are threatened by cashing lower revenues from oil sales. And that puts pressure firstly on their ability to finance social programs and, secondly, on maintaining their financial ratings; the first is necessary to ensure internal peace and stability, the latter being necessary for quick and cheap access to loans on international financial markets. Both are indispensable for the political stability of the regimes in those states.
This is also the mechanism envisaged earlier this year by the Citigroup analysts, who stated, quoted by the news agency Bloomberg, that cheap oil is at the same time both a stimulus to the economy and an enhancer for some existing tensions in geopolitical terms in different parts of the world. “Any such process of redistribution of capitals may produce numerous political and military tensions,” said Holger Schmieding, Chief Economist with Berenberg Bank, in support of the Citigroup analysts, in a report published in early January, also quoted by Bloomberg.
No matter how deep or not, and no matter how quickly they would take place, the shifts caused by the fall in oil prices creates the potential for a series of events that until recently seemed unthinkable, but now they can actually happen. Among them - according to Byron Wien, vice president of financial group Blackstone - might be a possible resignation of Russian President Vladimir Putin, even during 2015, and a possible completion of an agreement to end the Iranian nuclear program. Also, according to other analysts, a dampening aggressiveness of the Islamic State could be considered.
All assumptions, less credible now, have coverage even if only partial (at least for the moment!) by reality! Thus, in the case of Iran, it is clear that the shock induced by the fall in oil prices - which actually means a significant reduction in legal and/or illegal oil sales revenues - overlaps the already difficult situation the national economy is going through, as it already recorded losses of billions of dollars annually due to sanctions decided by the West due to lack of cooperation and transparency on the Iranian nuclear program. Thus, President Hassan Rouhani, sworn in on a wave of hope that he will be able to bring prosperity and to get Iran out of international isolation, is facing massive drops of the local stock market and sharp depreciation of the national currency. Beyond this unfavourable situation there is a major risk in 2015 of significant cuts of public programs (less investments, possible cuts of pension and/or public sector wages, etc.), as the budget is built on a oil price level of USD 72 per barrel - a level that already seems to be a bit too optimistic! All these factors lead to the conclusion that there are many issues that could force Iran to soften its position against the international community, which could mean even a potential agreement on its nuclear program.
Also, the terrorist formations known as the Islamic State - which finance much of their activities with money collected from the sale of oil from the fields captured in Syria and Iraq on the black market - could be forced to temper aggressions as a result of decrease in revenues. “Islamic State’s actions have distorted the political status in the Middle East. A lower oil price will therefore affect the Islamic State, as it will affect Iran and Russia, and will benefit the West,” said Bank of America-Merrill Lynch analyst Francisco Blanch in an interview with Bloomberg, bringing a new dimension to the analysis on how the fall in oil prices will contribute to reshaping the political and military situation in ‘warm’ zones of the world.
As far as Russia is concerned, the situation is very cloudy! Stress tests conducted in December last year by the Central Bank of Russia showed Russian economy could record in 2015 a decrease of about 4.7 percent of GDP if oil prices will remain on average below the USD 60 per barrel level. This would also incur serious problems to ensure funding for public programs and projects, all the more serious as the rouble has toughly depreciated against the major global currencies and the sovereign rating has been already lowered to the ‘junk’ level by some rating agencies.
However, a scenario of negative developments should not be excluded, the decline in oil prices can also be a tension factor. On short term at least, in the case of Russia, such a development is still quite likely. “The risk is that, like a cornered bear, Russia might have an even more aggressive approach, driven by despair, which would pose a real threat against the stability and the prospects of political status in Europe,” says the same Holger Schmieding, Chief Economist with Berenberg Bank. “Either way, the major blows received by the Russian economy lately will lead in time to a substantial abatement of Russia’s ability to fund the current conflicts and other confrontations of the same type in the future” due to the budget revenues decrease and reduced access to financing, he added. “The US, Europe, Japan, China and India will be strengthened, while the economies of Russia, Iran and Venezuela will weaken, which will make the world a safer place,” is Schmieding’s conclusion, in terms of changes in strength ratio at global level induced by the decline in oil prices.
CONCLUSIONS AND DOUBTS
Therefore, the effects on global economic mechanism and subsequent changes on the geopolitical level make the evolution of oil prices one of the major risks humanity might have to face in 2015.
25 years after the fall of the Berlin Wall the world is going through an unprecedented process of resetting of economic, social, political and military relationships, and the fall in oil prices is both a consequence and its enhancer. At least for now, a question remains unanswered, i.e. whether the fall in oil prices is a ‘tool’ used to determine the change in the status quo (both on economic, social and/or geopolitical level)... or is it just an ‘outcome’ of the process of rebalancing the balance of forces the world is going through.