The underlying cause of the Oil Price Drop?

Connections with the Oil and Gas Sector in excess of 30 years and first-hand  experience helping the ‘Majors’ successfully develop marginal fields for substantially less $10 a barrel in the mid and late 1990’s, mean that I have long been amazed at how the fall in oil prices has the effect it has. At a recent conference in Singapore several keynote speakers alluded to some key reasons. My suspicions were confirmed as it became clearer that maybe it was not the majors but in fact their investors who have cold feet when it comes to ‘price-drops’. The following Reuters News article is enlightening if nothing else and suggest the oil companies are perhaps the victims of investor pressure.

The dramatic fall in oil prices since the middle of last year cannot be explained by changes in production and consumption alone, with hedging and energy firms’ high debt levels also playing a part, the Bank for International Settlements (BIS) said on Saturday. The BIS, which represents central banks around the world, compared oil’s recent fall, which saw prices collapse to below US$50 a barrel from levels of above US$100, with declines in 1996 and 2006 and concluded that unlike on previous occasions, oil production has been close to expectations this time and consumption was only slightly below forecasts. While the recent decision by the Organization of the Petroleum Exporting Countries not to cut production has been key to the fall, other factors could have exacerbated it, the BIS said.

These included increased indebtedness in the oil sector in recent years. The Basel-based organisation said this greater debt burden may have had an influence on the oil market itself. “Against this background of high debt, a fall in the price of oil weakens the balance sheets of producers and tightens credit conditions, potentially exacerbating the price drop as a result of sales of oil assets,” it said. The BIS said reduced cash flows as a result of a lower oil price heightened the risk of firms being unable to meet interest payments and this could lead them to continue pumping oil to maintain cash flows, delaying a reduction in supply. This may be a particular factor in emerging markets, where a stronger dollar would hit indebted companies even harder. An increased reliance by oil producers on swap dealers as counterparties for their hedging since 2010 may also have played a part. Dealers may “at times of heightened volatility and balance sheet strain for leveraged entities … become less willing to sell protection to oil producers”, the BIS said. It said volatility in oil prices “suggests dealers may have behaved procyclically — cutting back positions whenever financial conditions become more turbulent”. This may have led producers wishing to hedge falling revenues to turn to derivatives markets directly and could have played a role in recent price movements. REUTERS


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