Oil prices are going to stay low - for now

Demand for oil over the near-term is likely to remain lackluster, given slow economic growth in most of the developed world and emerging markets. Meanwhile, conservation measures and environmental pressures are reducing long-term oil demand. Oversupply is also likely to persist, at least for the foreseeable future.

Some dispute that the oil prices have entered a new range of $20 to $60 per barrel. Others see the fall as temporary, seizing the opportunity to purchase assets cheaply.

Prince of Oil since 2006

Saudi Arabia and OPEC are unlikely to adjust production significantly. Oil minister Ali al-Naimi has pointedly stated that Saudi Arabia will not cut production even if oil prices CLG5, -5.26% fall to $20 per barrel. It is a historical shift, emphasizing market share rather than high prices, by controlling supply. Underlying the strategy is the focus on allowing low cost, efficient oil producers to increase their market power.

As the world’s largest crude oil exporter, Saudi Arabia is well-placed to implement this long-term strategy. It commands 25% of the world’s oil reserves. It has invested to maintain 2 million barrels per day spare capacity (over 80% of global spare capacity). It also has about $900 billion in foreign assets, giving it the wherewithal to survive significant revenue declines from lower oil prices for an extended period.

Countries with a dependence on oil-related revenues will be forced to increase production to maintain cash flow. The U.S. shale oil industry has more capacity coming on-stream and is likely to increase production, despite economic pressures, focusing on cash flow rather than profitability. High-leverage and high-debt servicing commitments will drive this behavior.