Understanding the low oil price era

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Understanding the low oil price era

The West Texas Intermediate that had been trading at more than $100 per barrel through June 2014 traded at $40.75 as of Wednesday. So far this year, the price of crude oil has been trading between $40 and $60.

Since August, even the $40 level has been threatened, which is a clear sign that the global economy has entered an era of low oil prices.

The big question is: How long will it last?

The general consensus among experts is that the low oil prices will likely continue for the foreseeable future because of conditions in supplying nations.

The price of crude is normally determined by a classic balance between supply and demand. When prices go up, supply follows. When prices fall, so does supply. But today’s crude market isn’t operating that way.

In September, Saudi Arabia was producing an all-time high of 10.20 million barrels a day, on average. But in late August, oil prices had hit a historical low of $38.24 per barrel.

At a time when oil producers should be reducing supply, they’re moving in the opposite direction and increasing production - largely due to the United States and Iran.

“Saudi Arabia is holding out against U.S. shale gas producers, but at the same time, it’s difficult to ignore the influence that Iran has as a predominately Shiite nation,” said Park Joong-je, an Korea Investment & Securities analyst.

Islam is largely divided into two branches: Sunni and Shia Muslims. Sunnis account for 85 percent of all Muslims worldwde, constitute the majority in Saudi Arabia, and are typically friendlier towards the west.

The civil war in Syria, which has fractured into the ongoing conflict involving the Islamic State, began in part because of the divisions between Sunnis and Shiites.

Due to that conflict, experts say it would be meaningless for Saudi Arabia to reduce its crude production, as predominately Shiite nations including Iran would fill in to keep oil prices low.

As a result, Saudi Arabia isn’t doing anything - for now. But experts are split on how long the low oil price era will last.

In the recently published World Energy Outlook, the International Energy Agency gave two possible scenarios for crude prices: either they rise to $80 per barrel or hold strong around $50 or $60.

“The reason experts are split on the outlook is because of the American shale gas industry,” said Park So-yeon, analyst at Korea Investment & Securities. If the shale gas industry fails to grow, it won’t be able to expand its production, resulting in oil prices rising to $80 per barrel. But if shale gas succeeds in lowering its production costs and overcomes issues like the passive loans provided by banks and lack of workers due to restructuring, crude price will continue to be traded around the $50 and $60.

Crude prices have been playing a critical role in the Korean economy, and are seen as one of the primary reasons for Korea’s low inflation rate. The average inflation rate in the first 10 months has been 0.62 percent, according to Bloomberg’s consumer price index. According to a report by Korea Investment & Securities released on Thursday, this year’s annual inflation growth is estimated to be 0.6 percent. Kyobo Securities projected at 0.7 percent. Even the Bank of Korea in October projected 0.7 percent, which is 0.2 percentage point lower than the 0.9 percent projection made in July.

Bank of Korea Gov. Lee Ju-yeol earlier this week raised concerns over the impact of low oil prices on the global market, which will increase the downward pressure on the already-struggling Korean economy.

“In some parts there are growing concerns of a deflation caused by low crude price,” the governor said.

BY JUNG SUN-EAN, LEE HO-JEONG [lee.hojeong@joongang.co.kr]
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