The Backdrop

The recent oil price dropped to multi-year lows and has been a cause of worry for the global economy as this fall has been impacting the oil producers and oil-services companies for a while. But, U.S. shale-oil producers are still refusing to leave the business mainly owing to two reasons, namely, the adoption of strategies related to dropping well-drilling costs and oil prices still trading above producers’ marginal costs. This encourages them to increase output to make up for falling revenue. Further drops in oil prices will add to the woes of African exporters. On the other hand, oil-importing countries including the U.S., Western Europe and Asia are winners from falling crude prices. India and Egypt, which subsidize domestic energy use, will also surely benefit. However, the gains are likely to be offset by currencies growing weaker against the US dollar.
 

The reason behind the price drop

Average oil prices have slumped from almost as high as $114 per barrel in 2014 to as low as $30 per barrel currently. This is mainly driven by oversupply in the market compared to the demand levels. While analysts indicate the rise to seasonal maintenance at refineries rather than shrinking global demand, factors clearly reflect supply demand imbalance. Also, recent statistics indicate total U.S. crude inventories at 494.9 million barrels which are levels not seen in about 80 years (as at January 2016).
 

Oil slide impact on companies

Led by a 20-month decline in oil prices, annual earnings of international oil companies have been hurt significantly. For 2015, BP PLC reported a full year loss of $5.2 billion with a replacement-cost loss of $2.2 billion for the fourth quarter alone. Chevron Corp revealed that it would cut its spending by $9 billion and lay off 4,000 workers in 2016 after reporting a surprise fourth-quarter loss of more than half a billion dollars. Particularly in Australia, Origin Energy which has also been hit by the oil price dip reported its December quarter revenue dropping 12% on the previous year. Similarly, Santos has announced for write-downs and cuts to oil and gas reserves in order to sustain the oil price volatility. With tumbling oil prices, we have also seen Woodside Petroleum and BHP Billiton flagging write downs in the recent times. Projects shelved, job cuts, cost cuttings and disposing assets are few significant blows that oil companies have been facing with the oil price slide.
 

Oil production freeze - The Iran side story

Global major oil producers are in talks to freeze oil output in order to curb crude production and thereby restrict the downfall in oil prices. However, Iran which is the major contributor in bringing back crude to the already oversupplied market, has not yet agreed for any freeze in its production levels. So far, Iran might have delivered an estimated 280,000 to 300,000 barrels a day from floating storage.
 

Saudi Arabia and Russia to freeze oil output

Saudi Arabia, Qatar, Russia and Venezuela reportedly agreed to freeze oil production at January levels if other oil-producing countries do the same. Saudi agreed with Russia to freeze oil output in order to reduce a near record supply glut, collapse in prices and thus stabilize the markets. This is the first significant cooperation between OPEC and non-OPEC producers in 15 years. January experienced multi-year highs in export levels from Russia and OPEC. Thus, the freeze, even if successful, would keep supply at a very high level. Industry analysts comment that the two big giants - Iran and Iraq - are highly unlikely to join the accord and agree for production cuts. Experts hint that the possibility of the agreement is very low exceptionally if Saudi indicated the right kind of deal in the Middle East.
 


Crude Oil and Russian International Reserves (Source: Thomson Reuters)
 

Conclusion

Based on the above stated facts and propositions, oil production freeze might be able to have an impact on the oil price slide to some extent. Some shortcomings like non-inclusion of the major giants in the deal and capping of production at January levels which are already high need to be tackled intelligently. All in all, the agreement is provisional but revolves around freezing the production that has led to some criticism coming in. On a positive note, this may lead to some concrete discussions and strategies going forward. At the same time, the latest medium-term outlook by International Energy Agency (IEA) stating that oil markets are expected to start to rebalance in 2017 at the back of the falling U.S. production which is thought to be short-lived while efficiency gains will push the U.S. output to new records in the next decade, might bring some respite. In fact, the U.S. output might touch a record 14.2 million barrels per day during the course of 2015 to 2021. Further, production of U.S. shale oil is expected to fall by 600,000 barrels per day in this year and then to 200,000 barrels per day next year before the expected recovery. However, global oil supply is expected to surge by 4.1 million barrels per day between 2015 and 2021. U.S. crude futures already surged above $31 per barrel post this update.

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