On a report published on Friday, Goldman Sachs Group forecasts that oil prices could go as low as $20 a barrel. The same day, Commerzbank announced a similar tumbling oil forecast.
This is a reaction to both weak demand and oversupply. Whilst the weak demand is something no one can control, the supply glut is very much intentional.
Fundamentally, the Goldman Sachs prediction is that oversupply will diminish in the second half of 2016 as US shale producers are forced out of the market. The Paris-based IEA concurred with this forecast, expecting that non Organization of Petroleum Exporting Countries (OPEC) production will fall by 500,000 barrels a day in 2016. 80% of this reduction or 385,000 barrels a day will be shale oil producers that currently cannot make a profit at less than $50 a barrel. But, surplus production is still much more than 500,000 barrels a day, which means that oversupply will continue to be a factor.
Oversupply is conscious. In June, US oil and gas production reached a 43 year high. By August, production levels are decelerating fast. That was largely the point. On August 30th, the U.S. Energy Information Administration issued a drilling productivity report forecasting a decline in shale production.
Major oil producers of cheap to produce onshore prime oil fields, especially Iran and Saudi Arabia are seeking to regain market share. Iran’s Oil Minister, Bijan Namdar Zanganeh, vows to increase output by 1 million barrels a day to gain market share. OPEC countries have also increased production. The glut was in many ways designed to push non-conventional oil, chiefly US produced shale oil and gas, but also offshore North Sea oil and Canadian tar sands.
The fundamental existential crisis for Saudi Arabia really begun when the US was transformed from a net importer to a net exporter for oil and gas in 2011. Much of this success story was due to the improvement of shale extraction technology. To address this crisis, Saudi has viewed tumbling oil prices as a process that could help Riyadh to regain market share. Over the last two years, Riyadh has essentially spearheaded an OPEC strategy designed to protect market share by increasing production, rather than cutting down to boost prices. Combined with demand deceleration from China, this strategy has started to work.
Perhaps more significantly, investment trends are beginning to tumble, especially in places with higher than average cost of development such as the Russian Arctic, the Gulf of Mexico, mid-Atlantic, and Canadian tar sands. Consultants Wood Mackenzie said in August that major oil companies shelved 46 large development projects, deferring $200bn of investments.
But, is this a victory?
Yes in that OPEC producers will gain market share. No, in that to maintain market share, an oil supply glut will have to be maintained so that production of shale remains unprofitable. This means lower profit margins for the foreseeable future. So this might be a phyric victory.