Volatile market shows mixed impact of oil slide

London

OPEC's failure to counter the oil price slump is expected to be followed by production cuts in the highly leveraged US fracking energy sector. But Friday's market volatility illustrates the mixed impact on the global economy.

The slide benefits consumers in Japan, China, Singapore, and other Asian, European and emerging energy importing nations. Negatives for energy producers on the other hand are severe. Besides the frackers in the US, the oil price crash hurts producing countries with inadequate finances, notably Russia, Iran, Venezuela, Libya and Nigeria.

The good news, from a geopolitical standpoint, is that the decision of the 12-member Organization of the Petroleum Exporting Countries (Opec) on Thursday to maintain output at 30 million barrels a day, or about a third of global production, places considerable pressure on Iran and Russia to come to an agreement with the US and its allies: Iran to end ambitions of obtaining a nuclear warhead and Russia to step away from Ukraine.

For some days, Saudi Arabia, the 12 million barrel a day producer, with the biggest sway in Opec, indicated that production cuts were unlikely. Despite the Saudi warnings, the Opec announcement precipitated a 7 per cent plunge in Brent oil quotes late on Thursday.

On Friday, global oil prices plunged to yet another four-year low. London Brent oil for January delivery sank in early deals to US$71.12 per barrel - the lowest level since July 7, 2010. US benchmark West Texas Intermediate (WTI) for January sank to US$69.29 a barrel in opening trade on the New York Mercantile Exchange (Nymex), down US$4.40 from Wednesday's closing price. The Nymex was closed on Thursday for a holiday, but in electronic trading WTI had slumped as low as US$67.75.

Opec secretary-general Abdallah Salem El-Badri did his best to put a positive spin on the decision after Venezuela and Iran had complained vigorously. "We don't want to panic. I mean it," he said. "We want to see the market, how the market behaves, because the decline of the price does not reflect a fundamental change."

He did not specify the current surplus of supplies over demand, but believes that the gap is only one to two million barrels a day at the most and a severe northern hemisphere winter could easily lift prices. In the meantime, analysts believe that financially secure Opec members with massive sovereign wealth funds, notably Saudi Arabia, Qatar and other Gulf states are aiming to place pressure on the US oil fracking industry which now need to cope with WTI oil prices of US$69, down 38 per cent from their 2014 peak.

T Boone Pickens, chairman and chief executive of BP Capital, a US energy investing company, believes the big issue in the oil market is neither Opec nor the strong US dollar. He maintains that US oil companies have "over-drilled for oil". "Now we've gotten ourselves in a spot. We need to slow down."

"Of course nobody wants to be the first to blink," he added on CNBC. "But when the domestic drillers start feeling real pain, they will blink."

Whether the US fracking industry likes it or not, financial circumstances may well force it to slash production.

Several analysts contend that the new oil companies which boosted their fracking production issued a lot of debt. Under US$70 a barrel production of several oil wells is uneconomical. The yields on the companies' junk bonds are rising because investors fear that some producers could go bankrupt. Since 2011, US energy firms have invested US$1.5 trillion into operations. They now account for more than 15 per cent of the US junk bond market, compared with less than 5 per cent a decade ago, estimates Alliance Bernstein.

Companies involved in exploration and production - known as "upstream operations" - could also be vulnerable. If oil prices fall further, growing numbers of companies will be under pressure and production of the industry will decline, analysts say. Banks which financed major oil deals such as a US$850 million loan to help fund the US merger of Sabine Oil & Gas and Forest Oil, could also be under pressure. Mr Pickens predicted, however, that the oil market will bottom in the first quarter of next year as mid-winter tends to be accompanied by greater demand.

The drop in prices has helped consumers in developed and other importing countries ahead of the Christmas holiday shopping season. Lower prices at the pump and on heating bills give consumers more money for discretionary items such as restaurant meals, electronics and fashion. The decline in petrol and other energy prices over the past six months is equivalent to a US$75 billion tax cut in the US, estimates Goldman Sachs.

*Oil rout: Losers and winners on SGX

*Is oil price plunge good or bad for global economy?