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Oil Price Falls and the cost of UK energy

Oil prices have slipped below $89, their lowest levels since 2010. That’s the headline but why the falls and what impacts will it have on the cost of energy?

The why?

  • Abundant supply
  • Burgeoning shale reserves
  • A strong dollar
  • Weak demand & a continued poor economic outlook

Abundant supply

Saudi Arabia, the world’s largest oil producer, and traditionally the key driver of OPEC policy has failed to follow its normal route and to rein in production in order to limit supply to boost the oil price. This is because it is battling potential market share losses to the likes of fellow OPEC members Iran and Iraq and returning Libya.

Ric Spooner, Chief Market Analyst at CMC Markets commented that:

“We’ve arrived at a pivotal support level for both Brent and West Texas Intermediate [the global standard oil indexes]. $85 is the area where OPEC has intervened in the market in the past”

Indeed the Saudis had originally promised to keep the oil price above $100 through their demand and supply machinations yet that commitment has dissipated in the light of good old competition and the downward pressure of surplus supply.

Indeed the Saudis have recently cut prices as a recovering Libya returns to full production capacity, Iran’s sanctions begin to soften and even ISIS affected Iraq maintains a significant production and export presence form the south of the embattled region.

The Saudis have historically played the role of a ‘swing producer’, that is a country willing and able to adjust its output to stabilise prices. The geo-political nature of the oil market is preventing them being able to exert that influence.

Edison Investment Research Analyst Peter Dupont commented:

“OPEC will probably attempt to cut production in the coming months but is likely to have difficulty in accommodating non-OPEC production growth plus rising production in Libya and potentially in Iraq and Iran”

The result of which may see OPEC slashing production, only for that shortfall to be filled by non-OPEC producing countries at lower prices, further deflating the market.

Burgeoning shale reserves

It is estimated that if the oil price fell to $80, a fall of just 10% from today’s levels having already fallen 23% since late June, then the on-going viability of shale oil projects in the US will be at risk.

Yet it is these very projects that are contributing to the downward pressure on the cost of a barrel of oil.

Nearly 10% of worldwide oil production is now coming from shale reserves in the US with production between 9m and 12m barrels of oil per day.

This shale ‘revolution’ has done wonders for the US, disconnecting it from the global energy ‘complex’, reducing the need for imports through increased self-sufficiency. This in turn has led to surplus stocks amongst exporters and has added to export volumes as the abundant shale extraction replaces US coal stocks as the fuel of choice, with the latter then needing to find new markets in order to remain commercially viable.

Richard Mallinson, an analyst at Energy Aspects, said:

“Over the past three years US production growth has been helping to balance the market at a time of global supply disruption. Shale oil from the US has replaced these lost barrels almost one for one and prevented prices going higher.”

Whilst this is good news for the US and the market it is less so for OPEC as their share of global production contracts so does their ability to control prices, requiring ever larger reductions to deliver the desired effect of price support.

A strong dollar

The third factor in a diminishing oil price is the continued strong performance of the dollar against other currencies, which is simply exacerbating the current impact of downward price pressure on oil as the trading currency of oil reserves.

Weak demand & a continued poor economic outlook

Alongside a glut of supply, booming new energy sources and disadvantageous exchange rates comes the backdrop of a world still recovering from recession, and that recovery is still in question.

Indeed the IEA (International Energy Agency) have signalled a sharp cut in its estimation of growth in the demand for oil whilst the IMF’s (International Monetary Fund) outlook for global economic growth is equally bearish. With two key organisations predicting sluggish growth and market imbalances as yet to fully recover from the global contraction the ‘sentiment’ for oil price growth simply does not exist.

What will the impact on energy prices be?

Whilst undoubtedly the US is benefitting from the shale boom and the added value of their new found coal exporting status, and central Europe experiences downward pressure on gas contracts linked to the price of oil, the picture in the UK is less rosy.

Sadly, in the UK, the impact of the fall in oil price may be felt at the petrol pump but not in the boardroom. Unlike on the continent, gas prices in the UK are not directly indexed to the price of oil, there is some connection there, but not enough for a fall, even a sustained one, to have a consistent and marked impact on the UK gas price.

Following on from that, the use of oil in electricity generation is now very small scale and though gas is a far larger generator, the influence of the oil price on it is, as we can see above, limited.

Our shale revolution is no more than headlines in the newspapers right now, with little actual exploration and next to no agreement on active extraction or even its true potential. We, as an energy-consuming nation, simply must rely on what we’ve got and merely look on with envy as to the US’s head start to self-sufficiency and cost reduction.

Allied to this are the more direct issues of demand and supply in the UK with both gas and nuclear stations currently offline, uncertain winter forecasts and diversion of resources into filling these ‘gaps’, the ‘surplus’ as seen elsewhere are simply not a feature of the UK energy market.

Indeed, the price of energy is now on a par with October 2013, far in excess of the low levels seen in July 2014, almost as if the falls of 2014 never happened.

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