Why oil price volatility persists and is here to stay?


by Arvind Ahuja

B.Sc., MIMarEST, CEng, MBA

Al Zahra Ship Operations and Management LLC

2016 was a challenging year, with tight financial markets with low liquidity, restricted cash flows limiting investments in new projects and expansions, a high number of payment defaults, low crude prices hurting the oil and gas industry, removal of subsidies and introduction of taxes or higher interest rates by the oil exporting countries.

For the maritime industry, with its overcapacity choking the freight rates, bulk carriers and dry cargo fleets were the worst hit with Hanjin’s failure highlighting the severity of the crisis.

Oil tankers had a better year as traders, in anticipation of rise in oil price, loaded and stored millions of barrels on ships at sea, causing a shortage of available ships and an increase in freight rates. The upside for the common man was cheaper fuel for cars, planes and ships, travel costs remained affordable and consumables economical.

The aggressive exploration and production of shale gas by the USA and reduction in imports by over 70% meant a loss in revenue to the exporters. By keeping the price of crude oil below USD $70 per barrel, which is the cost of production for shale gas, OPEC effectively mitigated the threat from shale gas.

 The revenue per barrel was lower but export volumes remained high. In most cases, the exporting nations have old rigs and equipment where the cost of production from these paid-off units is below USD $8 per barrel. This offsets the cost of USD $40 per barrel from the newer rigs and FPSOs.

The other contributing factor for the lower prices is the lower consumption by China and OPEC did not cut production to bring up prices. There are murmurs that oil prices have also been kept down intentionally, to restrict an economic boom in Iran and to prevent higher defense spending. It is also rumored that the prices are being kept low to prevent Russia, with its oil export dependent economy, from supporting war operations in the Ukraine, Syria and Yemen.

In the UAE and Arabian Gulf, the effect of the reduction in oil prices was visible as oil exploration projects were shelved and vessels laid up. People in the offshore industry lost jobs or saw reduced salaries.

The availability of a large number of qualified and experienced personnel, setting up their own SMEs or returning to sailing on ships, meant reduction in salaries or reduction in earnings for existing players.

The recent cut in production declared by OPEC has buoyed the oil prices, making it profitable but this will make consumables dearer for the common man and this price level is not adequate to kick-start the shelved projects.

2017 is expected to be a volatile year with unexpected spikes and dips in oil prices as the markets react to geo-political developments.