Tuesday, 17 March 2015

Why there was a sudden trend reversal in oil prices?

A recent trend shows a continuous fall in oil prices. Brent Crude Oil hit its lowest at US$45 per barrel in January 2015 after fluctuating around $50 the previous months.

In other words, oil prices fell by more than half within six months, since it still fluctuated around
$115 back in June 2014. This sharp trend reversal occurred in late 2014 after a period of oil-price hikes in the past decade.

Prior to 2014, in line with the rapidly growing Chinese and Indian economies, oil producers tried to keep up with the rising demand for oil from China and India.

During the high-oil-price period, many companies started to find it profitable to begin extracting oil from difficult-to-drill places, which led to the shale-oil boom in the US, adding more supply to the global oil market.

However, by the late 2014, in line with the economic slowdown in China and India, demand for oil decreased and the accumulated oil supply had surpassed its demand.

Usually during this condition, OPEC, the world’s largest oil cartel, would cut back on production to bring prices back up. Nonetheless, Saudi Arabia did not want to cut production to maintain its market share, thus exacerbating the price even further.

Meanwhile, the shale-oil production boom in the US only inflamed this matter even worse. Subsequently, oil prices slumped dramatically through the fourth quarter of 2014.

Over the last couple of weeks, however, oil prices have been recovering again. On Feb. 27, Brent Crude Oil reached $61 per barrel, rebounding almost 16 percent within February and made its first monthly gain since June 2014.

One of the triggers of this trend reversal is the decline in drilling. The recent free-fall in oil prices has hurt many oil drillers.

According to Bloomberg, this condition has caused many drillers in the US to cease drilling, which forced these companies to delay investment plans and lay off workers.

This decline in drilling will result in lower production and signals slower supply growth in the near future. In response to this condition, the US Energy Information Administration reduced its US crude oil production from 9.42 million barrels a day (mbd) to 9.3 mbd by the end of 2015.

On the other hand, demand also shows some improvements albeit tiny. For instance, a report by Reuters suggests that oil demand in China is set to grow 3 percent in 2015, which is above the forecast from the International Energy Agency of 2 percent. Higher demand will potentially be able to push oil prices up.

Nevertheless, plenty of energy analysts suggest that the higher demand is primarily caused by the very low oil prices in January 2015.

In other words, there is a risk that this stronger demand will fade once the prices go up again. Subsequently, it might not be able to bring a robust rise in oil prices.

In short, after hitting lower levels in January 2015, oil started to become bearish again throughout February 2015, spurred by the lower supply growth and slightly higher demand growth. Nevertheless, the current situation still poses some uncertainties vis-à-vis the strength of the oil price recovery considering demand growth could still fall again.

Looking at this condition, overall, it could be implied that oil prices will be relatively higher by the end of 2015 compared to that of 2014 even though a sustainable rise is not expected.

Meanwhile in Indonesia, oil-price fluctuation plays a crucial role in affecting the country’s macroeconomic conditions, whether from the current account in its balance of payments, fiscal balance and inflationary pressure.

The recent drop in oil prices has allowed the government cut the subsidized oil prices, which resulted in relatively better trade balance and milder inflationary risk.

Nevertheless, looking at the sudden change in oil prices in the last couple weeks, the government has to be cautious in anticipating the fluctuations in oil prices in the near future. If the trend continues, the government has to readjust its subsidized oil prices in order to maintain its fiscal room. Otherwise, the government could experience over-spending, which could exacerbate its fiscal deficits.

However, rising subsidized oil prices may put pressures on inflation. Therefore, policy coordination between government agencies has to be strengthened in anticipating the fluctuation in oil prices.

In addition, the government also has to provide policy communication to the public in order to maintain public confidence and expectation. If this can be carried out, the government can anticipate higher oil prices with stable fiscal room and trade balance conditions while preserving price levels and public confidence.
The writer is a graduate of the University of Manchester.
- See more at: http://www.thejakartapost.com/news/2015/03/03/why-there-was-a-sudden-trend-reversal-oil-prices.html#sthash.idSfkgcb.dpuf

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