Squeezing the Frackers

The price drop of crude oil has dominated headlines since July 2014. Shortly after the commodity price peaked at $115 per barrel in June last year, the price of oil, the commodity that has become emblematic of the late 20^th century – began to unremorsefully capitulate. Oil prices have dropped by 60% to below $50 a barrel and against a backdrop of scares over running out of oil, the world suddenly has too much. So what happened and is it good or bad?

Here at Electric Corby we have an avid interest in all things energy and have investigated both the implications and the feasible causes of this unforeseen scenario.

So what’s causing all this? Over the last 30 years America has gone from being one of the largest net importers of oil to becoming one of the largest producers in the world, and the U.S is currently at its highest level of oil exports in 57 years. Much of this has been accomplished through fracking, to unleash what has been referred to as ‘tight oil’. Through this process the U.S added three million barrels per day between January, 2011 and July, 2014. To put this into context, the International Energy Agency had forecast global oil demand would rise by 900,000 barrels a day and then latterly reduced oils forecasted growth in demand to 700,000 barrels a day over 2014. This highlights the growing imbalance between supply and demand. When supply exceeds demand, this is often reflected in a price drop.

One explanation for the drop in the price of oil is that the Saudi’s have decided to flood the market to regain control, regardless of the cost. OPEC has long been responsible for controlling the global supply of oil, and subsequently the price of its shared commodity for the benefit of its members. The growth of fracking is a threat to OPEC, and its most prominent member, Saudi Arabia. It represents a significant and growing supply outside their control, and even more concerning it gives the US energy independence from OPEC.

How is this viable for Saudi Arabia? Very simple economics. The International Energy Agency estimates that oil from shale formations costs $50 to $100 a barrel to produce, compared with $10 to $25 from the Middle East and North Africa. Whilst a drop in the price of oil might reduce Saudi profits, it poses a significant threat to the American fracking industry.

In addition to “Squeezing the Frackers” it would appear the Saudi’s are also doing a little sabre rattling in the direction of Russia and the OPEC membership, demonstrating in unforgiving economic terms, who is in control.  Of the 12 member states of OPEC, five are in dire straits with internal political issues. In addition to this, Russia, the second largest global exporters, continue to edge precariously towards global isolation and financial meltdown.

The ultimate question though, is how does this affect us, outside the murky, shadowy world of global politics? Clearly most of us have seen an immediate benefit in falling prices reflected in the cost at the petrol pump, and reductions in the cost of gas and electricity. Moreover, if we examine the relationship between the price of crude oil and energy, the full extent of the fall in crude has not been reflected in the energy market so we expect to see further price reductions over the next few months.

So unless you work in Aberdeen, the falling price of oil is probably something that will benefit you. While it may not be good for price stability and investment planning in energy projects, that is a discussion for another time. In summary, enjoy it while it lasts, the continuing use of a finite and volatile resource may only result in reducing supply, so when either the Saudi’s have achieved their goals, or the global market and geo-politics underpinning it stabilises, we should see prices rise again.