(EnergyAsia, January 8 2015, Thursday) — The collapse of oil prices has injected new political, economic, financial and social risks into an already uncertain global environment grappling with heightened geopolitical conflicts and economic uncertainties, said the International Energy Agency (IEA) and oil companies.

Caught out by the 50% price plunge since mid-2014, some shale-based operators in the US, heavy oil producers in Canada and deepwater explorers have been forced to sharply cut their capital expenditure in 2015, and possibly beyond.

State-owned firms like Malaysia’s Petronas said it plans to slash budgets by up to 20% on the basis of Brent crude selling at an average US$75 a barrel in 2015. Since December 17, Brent has fallen below US$60 and is now on course to test support at US$50.

Russia’s economy could shrink by at least 4.5% this year and around 1% in 2016 on account of low oil and gas prices, and sanctions imposed by the West on its economy for the dispute over Ukraine. Venezuela and Iran, two of OPEC’s most anti-Western nations, are faring much worse, with riots becoming common in Caracas as mass panic sets in over shortages of essential goods and fears of hyperinflation.

“The resulting downward price pressure would raise the risk of social instability or financial difficulties if producers found it difficult to pay back debt,” said the IEA.

The pain threshold varies widely across oil-producing countries, according to the International Monetary Fund (IMF).

In a study released in October, it found that pro-western Kuwait, Qatar and the UAE are capable of achieving a balanced budget with oil at about $70 a barrel while sanctions-hit Russia needs US$101 and Iran US$136. Politically fractious Venezuela and conflict-ridden Nigeria each require US$120 oil to keep alive vital social programmes.

The special case of Saudi Arabia

For all its bravado, even Saudi Arabia is going to feel the pain for crashing its own oil party in the form of incurring a record 145-billion riyal budget deficit for 2015. (US$1=3.75 riyal).

Announced on Christmas Day, the 2015 budget assumes an estimated 16.3% reduction in the kingdom’s mostly oil-derived revenues to 715-billion riyal against spending of 860-billion riyal. Oil still accounts for around 90% of the Saudi government’s revenues.

Based on an average Brent crude price of US$60 a barrel, Saudi Arabia expects to see a near 50% drop in this year’s oil revenues compared with 1,035-billion riyal in 2013. The kingdom, which plans to maintain oil production at around 9.6 million b/d, expects to earn around 930-billion riyal this year.

However, the Saudis along with the pro-western regimes of Kuwait, Qatar, the UAE and Oman are far better positioned to ride out a prolonged period of oil price weakness. Saudi Arabia has amassed an estimated US$750 billion for foreign exchange reserves to more than compensate for any losses in oil export revenues over the next few years.

In authorising the Saudi government to draw on its financial reserves to cover the budget deficit, King Abdullah bin Abdulaziz Al Saud is using the kingdom’s new found financial muscles to  beat up the oil competition.

Making a note of Riyadh’s  “strong external and fiscal positions”, ratings agency Standard and Poor’s has underlined the government’s success in building up the kingdom’s non-oil sector and financial investments over the past decade.

While Saudi Arabia’s financial health may be robust, the same cannot be said of its ageing King Abdullah, who is in his early 90s and believed to be in frail health. News of his admission to hospital for medical tests alone was enough to send Saudi stocks plunging 6.5% on the last day of 2014.

While the kingdom’s succession plans are in place with 79-year-old Crown Prince Salman the designated heir apparent, there are concerns that a transition of power now in the midst of the oil price slump and threats from the Islamic State could provide an opportunity for political unrest. The King supported oil minister al-Naimi’s risky strategy to let prices go into freefall and potentially threaten the economy.

Among oil companies, ExxonMobil is well-positioned to weather markets conditions with crude at US$40 a barrel, said chairman and CEO Rex Tillerson. Speaking at CNBC’s Business Roundtable summit in December, he said ExxonMobil’s “massive” liquefied natural gas and deepwater drilling projects are decade-long investments that have been tested to perform across a broad range of price ranges, from US$40 to US$120 per barrel.

With Saudi Arabia-controlled OPEC sticking to its position, consultant Wood Mackenzie said the onus will fall on producers outside the cartel to scale back their supply.

“Weaker than expected global economic growth could put even more pressure on prices. Oil companies will be forced to adapt, and a buyers’ market could emerge in 2015,” said Paul McConnell, Wood Mackenzie’s principal analyst for global trends.

China looms large

China will remain a vital factor, and its slowing energy and commodity demand growth will require suppliers to adjust. The Chinese government is expected to announce more policy changes in 2015 that will shape the country’s economic growth as well as its energy demand growth over the medium term.

“A twin-pronged approach to environmental protection and support for domestic mining companies means a shift to cleaner coal consumption and a reduction of seaborne imports,” said Mr Connell.

“Details of the 13th Five Year Plan will become clear in 2015, but are likely to accelerate the drive towards a more sustainable China. Such policies could mean further damaging impacts on global coal producers.”

Longer term, he said “deep-seated geopolitical, economic and technological trends” may point to a new era of weak hydrocarbon demand growth.

IEA: Supply-demand forces need time to adjust to price collapse

It will take time for supply and demand forces to respond and eventually adjust to the shock of 2014’s oil price collapse which few have foreseen, said the IEA. The conditions for the oil market’s collapse were created by several years of record high prices, which encouraged the record surge in non-OPEC supply and a contraction in global demand growth to five-year lows.

Six months of sharply lower oil prices have led to producers slashing spending, but this will affect output in the medium- and long-term as near-term supply remains abundant. It will take a long time before the current price shock works its way through the supply chain.

The IEA expects most projects that have already been funded to proceed through implementation.

“Today’s oil spending cuts will dent supply – just not right now,” it said.

Non-OPEC supply growth for 2015 will not come close to its 2014 record, due largely to the slump in Russia.

With OPEC refusing to budge, the IEA expects Russia to trim production in response to the collapse of both oil prices and its currency along with the worsening impact of western sanctions on Moscow over their struggle to control Ukraine.

Earlier, Russia‘s Deputy Energy Minister Kirill Molodtsov had insisted that his country would maintain production at 526 and 528 million tonnes or more than 10.5 million b/d.

Meanwhile, North America, particularly the US, will continue to boost supply in the near-term, said the IEA.

“The short-term outlook for US light tight oil production remains unchanged at current prices as long as producers maintain access to financing,” said the Paris-based agency.

As for demand, the IEA said the stimulus effect of the oil price collapse on the global economy will be modest, dashing the hopes of many who have been comparing it to a major tax cut.

“For producer countries, lower prices are a negative:  the more dependent on oil revenues they are and the lower their financial reserves, the more adverse the impact on the economy and domestic demand,” said the IEA.

Russia, along with other oil-dependent but cash-constrained economies, will not only produce less but is likely to consume less in the coming months.

In oil-importing countries, the IEA said price effects are asymmetrical.

“Demand lost to substitution or efficiency gains during prolonged periods of high prices will not come back in a selloff,” it said.

“Several governments are wisely taking advantage of the price drop to cut subsidies. Consumers thus might not see much of the decline.”

The US dollar’s strength and oil sale taxes in some countries will also limit the feed-through from crude oil to retail product prices.

In the developed economies, the agency said a tepid economic recovery, weak wage growth and worrying deflationary pressures will further blunt the stimulus of lower prices.



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