Oil Pressure Affecting Broader Markets

It’s been almost a year since oil prices started sliding, with a combination of oversupplied markets and soft demand pushing prices lower. On the supply side, US production hasn’t declined at the pace that many in the market were banking on earlier this year, with declines at the Shale fields being offset by new volumes from big offshore fields in the Gulf of Mexico (GoM).

A number of major producers in the offshore region like Chevron (CVX), Shell (RDS.A) and Anadarko (APC) have gone ahead and hooked up production from new GoM fields despite the low prices. Since these offshore projects take a very long time to develop, operators prefer to bring them online as soon as possible in order to start recouping their investments. Growing GoM volumes notwithstanding, overall US production is coming down from the multi-year record early in the year.

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Beyond the US, OPEC has been producing above its quota for a while which the cartel failed to curb at the Friday meeting. There are multiple reasons for the cartel’s inability to police its members’ production, but rivalry between Iran and Saudi Arabia remains the core issue. It was OPEC’s Friday meeting which served as the latest catalyst for pushing prices lower.

The supply situation is expected to get even worse in the coming months as Iran gets permission to export about one million additional barrels as a result of its nuclear deal with the US The bottom line is that global crude oil inventories remain above historical levels, and producers are struggling to find storage facilities for their barrels. All this at a time when demand growth has slowed notably as a result of economic slowdown in China and other emerging markets.

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But how could lower oil prices be bad for the market? The fact is that low oil prices are a net positive for the US economy. Despite the country’s strong gains in oil production in recent years as a result of the shale revolution, it is still a net oil importer, buying roughly half of its oil needs from abroad. The US is a domestic consumption-driven economy and low oil prices give a much needed boost to household buying power, which is a useful nudge in these times of depressed wages.

The concerning part of the oil slide is the question of what all of this means to companies in the oil patch. There are legitimate questions about the long-term viability of many oil producers in this oil environment, particularly their ability to service their debts and pay their dividends. It is these concerns that are giving market participants a pause at this fresh downtrend in oil prices.

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