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Posts Tagged ‘oil balance’

Will there be an oil price rebound?

People are beginning to get used to low oil prices and acting as if they are going to remain low. Oil is trading at only a little over $30 per barrel and Saudi Arabia is unwilling to backtrack on its policy of maintaining its level of production and not seeking to prevent oil prices from falling. Currently, there is still a position of over supply and hence in the short term the price could continue falling – perhaps to $20 per barrel.

But what of the future? What will happen in the medium term (6 to 12 months) and the longer term? Investment in new oil wells, both conventional and shale oil, have declined substantially. The position of over supply could rapidly come to an end. The Telegraph article below quotes the International Energy Agency’s executive director, Fatih Birol, as saying:

“Investment in oil exploration and production across the world has been cut to the bone, falling 24% last year and an estimated 17% this year. This is… far below the minimum levels needed to keep up with future demand. …

It is easy for consumers to be lulled into complacency by ample stocks and low prices today, but they should heed the writing on the wall: the historic investment cuts raise the odds of unpleasant oil security surprises in the not too distant future.”

And in the Overview of the IEA’s 2016 Medium-Term Oil Market Report, it is stated that

In today’s oil market there is hardly any spare production capacity other than in Saudi Arabia and Iran and significant investment is required just to maintain existing production before we move on to provide the new capacity needed to meet rising oil demand. The risk of a sharp oil price rise towards the later part of our forecast arising from insufficient investment is as potentially de-stabilising as the sharp oil price fall has proved to be.

The higher-cost conventional producers, such as Venezuela, Nigeria, Angola, Russia and off-shore producers, could take a long time to rebuild capacity as investment in conventional wells is costly, especially off-shore.

As far as shale oil producers is concerned – the prime target of Saudi Arabia’s policy of not cutting back supply – production could well bounce back after a relatively short time as wells are re-opened and investment in new wells is resumed.

But, price rises in the medium term could then be followed by lower prices again a year or two thereafter as oil from new investment comes on stream: or they could continue rising if investment is insufficient. It depends on the overall balance of demand and supply. The table shows the IEA’s forecast of production and consumption and the effect on oil stocks. From 2018, it is predicting that consumption will exceed production and that, therefore, stocks will fall – and at an accelerating rate.

But just what happens to the balance of production and consumption will also depend on expectations. If shale oil investors believe that an oil price bounce is temporary, they are likely to hold off investing. But this will, in turn, help to sustain a price bounce, which in turn, could help to encourage investment. So expectations of investors will depend on what other investors expect to happen – a very difficult outcome to predict. It’s a form of Keynesian beauty contest (see the blog post A stock market beauty contest of the machines) where what is important is what other people think will happen, which in turn depends on what they think other people will do, and so on.

Webcast
At $30 oil price, shale rebound may take much, much longer CNBC, Patti Domm , Bob Iaccino, Helima Croft and Matt Smith (25/2/16)

Article
Opec has failed to stop US shale revolution admits energy watchdog The Telegraph, Ambrose Evans-Pritchard (27/2/16)

Report
Medium-term Oil Market Report 2016: Overview International Energy Agency (IEA) (22/2/16)

Questions

  1. Using demand and supply diagrams, demonstrate (a) what happened to oil prices in 2015; (b) what is likely to happen to them in 2016; (c) what is likely to happen to them in 2017/18.
  2. Why have oil prices fallen so much over the past 12 months?
  3. Using aggregate demand and supply analysis, demonstrate the effect of lower oil prices on a national economy.
  4. What have have been the advantages and disadvantages of lower oil prices? In your answer, distinguish between the effects on different people, countries and the world generally.
  5. Why is oil supply more price elastic in the long run than in the short run?
  6. Why does supply elasticity vary between different types of oil fields (a) in the short run; (b) in the long run?
  7. What determines whether speculation about future oil prices is likely to be stabilising or destabilising?
  8. What role has OPEC played in determining the oil price over the past few months? What role can it play over the coming years?
  9. Explain the concept of a ‘Keynesian beauty contest’ in the context of speculation about future oil prices, and why this makes the prediction of future oil prices more difficult.
  10. Give some other examples of human behaviour which is in the form of a Keynesian beauty contest.
  11. Why may playing a Keynesian beauty contest lead to an undesirable Nash equilibrium?
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Influences on the UK current account

Newspaper headlines this week read that the UK’s balance of trade deficit has widened to £34.8bn, the largest since 2010. And when you exclude services, the trade in goods deficit, at £119.9bn is the largest ever in nominal terms and is also likely to be the largest as a percentage of GDP.

So far so bad. But when you look a little closer, the picture is more mixed. The balance of trade deficit (i.e. on both goods and services) narrowed each quarter of 2014, although the monthly figure did widen in December 2014. In fact the trade in goods deficit increased substantially in December from £9.3bn to £10.2bn.

At first sight the widening of the trade deficit in December might seem surprising, given the dramatic drop in oil prices. Surely, with demand for oil being relatively inelastic, a large cut in oil prices should significantly reduce the expenditure on oil? In fact the reverse happened. The oil deficit in December increased from £598m to £940m. The reason is that oil importing companies have been stockpiling oil while low prices persist. Clearly, this is in anticipation that oil prices will rise again before too long. What we have seen, therefore, is a demand that is elastic in the short run, even though it is relatively inelastic in the medium run.

But the trade deficit is still large. Even when you strip out oil, the deficit in December still rose – from £8.7bn to £9.2bn. There are two main reasons for this deterioration.

The first is a strong pound. The sterling exchange rate index rose by 1.8% in December and a further 0.4% in January. With quantitative easing pushing down the value of the euro and loose monetary policies in China and Australia pushing down the value of their currencies, sterling is set to appreciate further.

The second is continuing weakness in the eurozone and a slowing of growth in some major developing countries, including China. This will continue to dampen the growth in UK exports.

But what of the overall current account? Figures are at present available only up to 2014 Q3, but the picture is bleak (see the chart). As the ONS states:

The current account deficit widened in Q3 2014, to 6.0% of nominal Gross Domestic Product GDP, representing the joint largest deficit since Office for National Statistics (ONS) records began in 1955.

This deterioration in performance can be partly attributed to the recent weakness in the primary income balance [see]. This also reached a record deficit in Q3 2014 of 2.8% of nominal GDP; a figure that can be primarily attributed to a fall in UK residents’ earnings from investment abroad, and broadly stable foreign resident earnings on their investments in the UK

The primary income account captures income flows into and out of the UK economy, as opposed to current transfers (secondary income) from taxes, grants, etc. The large deficit reflects a decline in the holding by UK residents of foreign assets from 92% of GDP in 2008 to 67% by the end of 2014. This, in turn, reflects the poorer rate of return on many of these assets. By contrast, the holdings of UK assets by foreign residents has increased. They have been earning a higher rate of return on these assets than UK residents have on foreign assets. And so, despite UK interest rates having fallen, as the quote above says, foreign residents’ earnings on their holding of UK assets has remained broadly stable.

Articles
UK trade deficit last year widest since 2010 BBC News (6/2/15)
UK’s trade deficit widens to 2010 high as consumers take advantage of falling oil The Telegraph, Peter Spence (6/2/15)
UK trade deficit widens to four-year high The Guardian, Katie Allen (6/2/15)
UK trade deficit hits four-year high Financial Times, Ferdinando Giugliano (6/2/15)

Data
Balance of Payments ONS (topic link)
Summary: UK Trade, December 2014 ONS (6/2/15)
Current account, income balance and net international investment position ONS (23/1/15)
Pink Book – Tables ONS

Questions

  1. Distinguish between he current account, the capital account and the financial account of the balance of payments.
  2. If the overall balance of payments must, by definition, balance, why does it matter if the following are in deficit: (a) trade in goods; (b) the current account; (b) income flows?
  3. What would cause the balance of trade deficit to narrow?
  4. Discuss what policies the government could pursue to reduce the size of the current account deficit? Distinguish between demand-side and supply-side policies.
  5. Why has the sterling exchange rate index been appreciating in recent months?
  6. What do you think is likely to happen to the sterling exchange rate index in the coming months? Explain.
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