(EnergyAsia, December 3 2014, Wednesday) — As panic grips oil and gas producers spooked by crude prices plunging to five-year lows, traders are  focused on how much lower the markets can go. US$100 is suddenly a distant memory while talk of US$150 oil has been consigned to unfounded fears associated with the Islamic State’s (ISIS) emergence back in June 2014.

After months of rumours, the Organisation of Petroleum Exporting Countries (OPEC), more specifically, Saudi Arabia, last month confirmed that the cartel will retain its three-year-old production quota of 30 million b/d despite evidence of a weakening global economy and surging global oil supplies.

With North America firing up its fracking operations and US production surging to a four-decade high of over nine million b/d, the world’s oil market will remain glutted in the near term.

But, the Saudis will not blink. Having allowed the US shale revolution to take root and deepwater production to expand over the past decade, the kingdom is ready to meet the competition head on.

With its economy in good shape and well prepared to stomach a price war, Saudi Arabia and its Arab allies have signalled they will accept a collapse in the oil price for several quarters if this will wipe out some of America’s marginal shale-based producers, Russia’s budding Arctic and Siberia upstream ventures with China, and deepwater activities in Asia, Africa and Latin America. In the extreme, the “nuclear solution” will have long-term consequences, potentially wiping out a lot of capacity now being developed to find and produce hydrocarbon in difficult terrains.

This was what happened during the 1998 crash when US$10 oil resulted in mass layoffs and budget cuts that set the stage for both Brent and WTI to surge to the record-high price of US$145 10 years later. Years of cheap oil encouraged rapid consumption growth throughout the world as governments relaxed conservation efforts.

The latest plunge will prove far more damaging than the previous two declines in 1998 and late 2008 as global demand grew for years even in the face of US$100 oil. If oil hits US$50-$60, demand will most certainly accelerate.

Prices could stay down for months after OPEC’s decision to retain current quota

Oil prices could slide further after hitting five-year lows in the wake of OPEC’s announcement last month that it will retain its production ceiling of 30 million b/d until its next meeting in 2015.

Following the end of the cartel’s bi-annual meeting in Vienna, US WTI crude futures settled at US$66.15 a barrel on November 28 for its lowest close since September 2009 while North Sea Brent briefly went below US$70 before settling at US$70.45, its lowest since July 2010. Oil prices have fallen by more 35% since mid-2014 as a result of the weakening demand outlook in China and Europe combined with growing supplies from the US and Saudi Arabia’s protection of its market share in Asia.

In a statement, OPEC said it expects non-OPEC supply alone to rise by 1.36 million b/d next year to more than cover any growth in global demand.

“The increase in oil and product stock levels in OECD countries, where days of forward cover are comfortably above the five-year average, coupled with the on-going rise in non-OECD inventories, are indications of an extremely well-supplied market,” the cartel said.

UK consulting firm Wood Mackenzie concurred: its own analysis found that global oil supply will grow at a faster pace than demand in 2015, continuing the trend from this year.

“The retention of current OPEC production levels clearly puts the outlook for oil demand growth as the continued focus of crude oil pricing and, in its absence, tight oil breakeven economics,” said Ann-Louise Hittle, Head of Macro Oils research for Wood Mackenzie

World oil demand growth has slowed markedly over the past year, making it more difficult non-OPEC production growth to be absorbed.

“There has been considerable speculation as to the motives of Saudi Arabia over recent months, as it has not cut its production significantly in spite of the drop in crude oil prices,” said Wood Mackenzie.

“With the agreement on November 24 to extend the talks with Iran to July 2015, one key near term supply concern for OPEC was removed prior to its meeting as Iran’s oil exports will not be stepping up in the first half of 2015. This price supportive factor has been lost in the OPEC meeting reaction.”

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