Crude economics drives down price of a barrel of oil

Oil prices are now languishing at less than $80 a barrel mark, around 30 per cent below a peak they hit in June and from which they have fallen with increasing momentum in the intervening months.

The reasons for the slump are simple, according to John Heffernan of Bord Gáis Networks. Supply is growing while demand is falling.

He believes that whatever happens in the short term this trend is likely to continue and we could see prices falling further, possibly down to $70 or even $65.

Supplies are increasing on a number of fronts. Production in Libya has been recovering, reaching one million barrels a day this year. This is below the 1.6 million that it was pumping out before the civil war in 2011, but it is well ahead of the 200,000 to which it fell during the conflict.

The US has been the star performer. Figures from its Energy Information Administration (EIA), a federal government body, show production neared 8.9 million barrels a day in August, 1.2 million more than during the same month last year. Heffernan says it is heading for 10 million, making the US the world's biggest producer.

Three basins, Bakken in North Dakota and Eagle Ford and Permian in Texas, are largely responsible for the growth. These are the main centres for shale oil, extracted by hydraulic fracturing – fracking – which involves firing tonnes of water at the face of the oil-bearing rock to crack it and release the oil.

It’s revolutionary in the sense that it has opened up vast amounts of reserves previously left untapped. Some estimates of Bakken’s original potential were 4 billion barrels, but the introduction of fracking bumped them up to 24 billion.

The technology is also controversial. Concerns voiced by environmentalists have stalled its introduction into many parts of Europe. However, this has not been an issue in the mid and southwestern US, as these areas are thinly populated.

“It has been a massive game-changer for the US,” Heffernan says.

On the demand side, sluggish developed economies and a slowdown in emerging markets, specifically China, means that the world's appetite for oil is more easily whetted.

The price hit its real inflection point in September when this trend prompted the International Energy Agency to pare back its demand estimates.

Two weeks ago the Paris-based agency predicted further price falls next year as “supply and demand imbalances continue”. At that point it estimated that production had crept up in October by 350,000 barrels a day to 94.2 million while consumption would be 92.5 million barrels a day next year, 200,000 less than originally thought.

Immediately following this big players in the US shale basins, such as ConnocoPhilips and Continental Resources, indicated that they may not add new drilling rigs in 2015. However, they acknowledged that they are fighting for market share with countries such as Saudi Arabia, so a cut in production seems unlikely.

Some observers believe that the Saudis are responding to that by ensuring that the Organisation of Petroleum Exporting Countries (Opec) does not reduce its production radically. By depressing the price they are hoping to take the momentum out of shale oil.

Another theory is that the cartel wants to put the squeeze on Russia, whose production costs are generally higher than the group's member countries.

Whatever the geopolitical machinations, the IEA believes that the trend in prices is likely to last.

The reality is that it has been building for some time, but the Arab spring democracy movement, the Syrian civil war and the conflict with Islamic State sparked fears about threats to supply that masked underlying trends by pushing up prices to $110 and $120 a barrel.

Hefferenan says what is happening is more than likely down to the industry’s own cycle. As prices rose between 2002 and 2012, investment in exploration and new production stepped up. There was a lag between the increase in demand and the extra quantities of oil coming onstream, but once that began to have an impact, it turned prices.

Once that process begins to gain momentum of its own, it becomes hard to stop. Reuters analyst John Kemp recently compared it to attempting to reverse a supertanker. He argued that prices will probably need to "over-correct" to turn the market around, which basically means continue falling.

In theory at least, that should be good news for some of us. Heffernan estimates that the recent price falls should effectively leave oil consuming nations $640 billion a year better off. So the question is: are the Republic’s consumers and businesses are going to see any benefits?

Tom Noonan, chief executive of Maxol Ireland, points out that forecourt petrol prices have fallen from around the €1.60 a litre mark in June to €1.44/€1.45, more or less 10 per cent. Diesel, which is around nine to 10 cent cheaper, has fallen at a similar rate. Heating oil prices are down around one quarter this year, he adds.

His industry points out that what you pay at the pump is not strictly tied to crude prices.

First, the State takes a large slice of the cake through excise and tax. If you paid €1.45 for a litre of petrol this morning the Government’s share will be 94.87 cent. VAT is paid at 23 per cent, other charges are fixed. The biggest is excise at 54.18 cent a litre for petrol and 42.57 cent for diesel, the next is carbon tax, which is 4.59 cent a litre for petrol and 5.33 cent for diesel.

The second factor at play is that you are buying a refined product, whose prices are influenced by trends other than those that impact on crude, such as seasonal increases in demand for heating oil or motor fuel. However, Noonan believes that motor fuel costs are travelling only one way at the moment. “The general trend is down,” he says.

The general energy picture is cloudier.

Electricity prices are determined by the cost of natural gas coal, oil, renewables and other fuels so a drop in crude is likely to have no immediate impact, although Heffernan said it should have some downstream impact. Gas prices are down on last year and this should feed through to homes and businesses.

However, all consumers began paying more for wind and turf generation last month when the public service levy, charged on every electricity bill in the Republic in order to support these industries, was increased. That will add €335.4 million to the overall cost of electricity between now and next October. Close to €170 million of this will be paid by the State’s biggest employers.

At the same time there appears to be no sign of the Republic’s high electricity costs falling dramatically in the short term.