Four Reasons for Lower Oil Prices that Have Reduced Ship Fuel Costs for Liners

By | 16/02/2015

Four Reasons for Lower Oil Prices that Have Reduced Ship Fuel Costs for Liners

With international oil prices at their lowest in four years, the shipping industry is giving a long-awaited smile.

Lower oil prices, which started last year, are stretching into this year. And its effects, which emerged in the fourth quarter of last year, are going to be more pronounced with the first quarter of this year. So, the shipping industry is looking forward to cost reduction, thanks to the lower international oil prices. On the other hand, one thinks of the negative effects of a downslide in oil prices, which should have its downside as well. Bronson Hsieh, Vice Chairman of Evergreen Group worried that reduction of slow steaming from the lowered oil prices should lead to oversupply of ships, thus exerting negative effects on the shipping industry.

Still, lower oil prices mean a blessing in the short term, as it improves profitability not only for the whole economy but specifically for the shipping industry. Then, what seems to be the reason for the unprecedentedly continuing downslide in oil prices?

 

Energy & Oil Price

WTI dated Nov. 28, 2014 (source: Bloomberg)

Begun last July, the worldwide downslide in oil prices has stayed the course. Futures price for crude oil WTI at New York Mercantile Exchange (NYMEX) dropped below 70 dollars per barrel, tumbling to 69.05 dollars as of Nov. 28, 2014. Now, the price is as low as 45 dollars.

 

The Lowest Crude Oil_WTI in five years

The Lowest Crude Oil_WTI in five years

Usually, oil prices tend to rise in winter. Why is that so, when it is summer in the Southern Hemisphere while it is winter in the Northern Hemisphere of Earth? This is because the Northern Hemisphere registers a higher concentration of countries, which burn oil through winter days. Currently, however, oil prices are falling “abnormally” when we are in winter. OPEC daily basket price, which lingered around 80 dollars per barrel, kept falling and has now dipped below 68 dollars.

Crude Oil_WTI_below 70 USD

Crude Oil_WTI_below 70 USD (Source: NYMEX)

 

Then, let’s take a look at the composition of international oil market, which is divided into three segments, broadly speaking.

  1. The first one is West Texas Intermediate, which is WTI, for short.
  2. The second one is Brent Crude from North Sea.
  3. The third is Dubai Crude.

WTI is mostly consumed in America (recently though, it is also exported abroad owing to sufficient supply of shale gas).

​And Brent Crude is spent mostly in Europe.

Lastly, Dubai Crude is supplied to consumers in the Middle East, Africa, and Asia.

One may safely think that the European gas price is linked to Brent Crude while the Asian counterpart is in sync with Dubai Crude.

Of course, that is not always the case. Only a fool would pay 200 won for Dubai Crude when Brent Crude is selling at 100 won close by.

Therefore, it is reasonable to believe that international oil prices are linked with one another.

​Then, shall we try to figure out what’s causing the downward movement for international oil prices?

For this, we can present four big reasons.

 

  1. Shale Gas Burst Out of the US, Starting in 2012.

​2012 witnessed the emergence of the much-talked-about shale gas in the United States, which took the worry out of peak oil. That’s what caused oversupply of oil.

Indeed, shale gas production led to a sharp drop in the US consumer price index.

Consumer Price in US fall on Cheaper Gasoline

The US economy experienced a continued fall in consumer prices in 2013 (source: Bloomberg).

​Even with the arrival of shale gas, however, oil prices lingered around 100 dollars per barrel. This suggests that it doesn’t make sense to try to pinpoint the phenomenon as the sole direct cause of the current levels of oil prices.

 

  1. Economy Retreats in Europe, China, and Japan

Experts worry about deflation in Europe, while there is concern that its GDP is possibly registering a negative growth from the second quarter of the year. So, Europe indicated possible asset purchases to pit itself against Abenomics of Japan.

Of course, it appears that such a possibility has come to nothing with the interest reduction by China, but it is an undoubted boon to the shipping industry. It is a good sign for the economy that somebody is pumping it up while trade becomes livelier.

In China, the real estate bubble is its biggest risk. And household debt and local government debt are not to be ignored, either. In Japan, Abenomics is approaching its limits, in spite of the phenomenal weaker yen. All these indicators began to pour out last July.

It is widely believed that the economic indicators for the three economies have driven oil demand to a further decline, thus influencing oil prices.

 

  1. Dodd-Frank Wall Street Reform and Consumer Protection Act Enacted in the US in 2010

​Dodd-Frank was signed into a law in the US in 2010 with a view to steering clear of an event like 2008 financial crisis. It was a regulatory measure imposed on the financial industry that Obama Administration came up with in order to control risky investment by depository institutions and their affiliates including banks and suppressing the aggrandization of banks and non-bank financial institutions. The law is also known as the Volcker Rule, as it reflects much of the idea of Paul Volcker, former FRB Chairman and former chairman of Economic Recovery Advisory Board under President Barack Obama. ​

 

Paul Volcker in Times

Paul Volcker in the early 1980s (Source: Time)

​​

​Notably, the Volcker Rule bans commercial banks from getting involved in speculative trading with their own money or with financial leverage.

It was around last April that Dodd-Frank went into force.

And it made it legally impossible for the financial institutions in the US to engage in speculative trading.

So what happened? Financial institutions could not but remove their related divisions.

It was in July that the removal began to show its effects.

With the disappearance of so-called speculative demand, the erstwhile bubble burst.

Moreover, oil is an inelastic product. So, the impact from such demand and supply is all the more cumulative.

Oil price change caused by speculative demand has been demonstrated through its sharp rise and fall in 2008.

 

Oil price in 2008

Oil price trends in 2008. Owing to the fear of peak oil, oil price sharply rose to hit 140 dollars before it nosedived to bottom out at 40 dollars.

 

  1. The Game of Chicken between the US and Saudi Arabia

It is true that the growing US power in oil market by virtue of its shale gas was the cause of Saudi Arabia’s anxiety.

Saudi Arabia is an oil power that takes up minimum 30% of the OPEC oil output.

The US supply of shale gas to the market served to add a downpouring supply to oil market, thus pushing oil prices further down with Saudi Arabia picking up the tab.

​To follow the past practice, when oil prices drop, OPEC countries collude to cut down oil production.

Considering the cutback in the oil production, oil prices automatically rise sharply.

Now that the American shale gas is buttressing the supply side, OPEC countries led by Saudi Arabia can no longer use such a strategy.

With regard to this, Prof. Craig Pirrong of University of Houston provided an interesting insight through his column (“The Saudis: Crazy like a Desert Fox?” Nov. 2014).​

​​He argues that Saudi Arabia is actually launching a counteroffensive. Breaking from its previous policy of cutting down oil production, the country is rather increasing oil production, thus instigating oil price drop through predatory pricing strategy.

Thus, if oil price drops to 100 dollars, Saudi Arabia must sustain the damage. But if the country pumps oil and thereby succeeds in pushing oil price further down to around 50 dollars, that will speed up the fall of the American shale gas suppliers and drive them out of the market. (In fact, the production cost for shale gas is reportedly 45 dollars at the minimum.)

To sum up, what’s happening is a battle for dominance of the international oil market.

Then, what is Obama’s take on this?

The US seems to rather welcome the development.

​The US is quite likely to hike its interest this year, as FRB is going to conduct an exit strategy.

In other words, when the US economy should be buttressed, falling oil prices influence consumer price index and thereby increase consumption. This would be a boon to the US economy.

Furthermore, as mentioned above, now that economy is retreating in Europe, China, Korea, and Japan, falling oil prices would stimulate those economies.

Lastly, citing the Ukrainian crisis, the US is imposing sanctions on the Russian economy.

Russia’s largest export is natural gas.

Falling oil prices should serve to decrease the Russian export.

This development is very unfavorable to Russia. Of course, the US would be gloating.

As a matter of fact, Russia has suffered 1,400-dollar loss.

The same is true of Iran, the challenger defiant against the US. As this affects Venezuela into the bargain, the purpose served is a foregone conclusion.

 

Oil war between Saudis and US shale

And here’s an analysis in this regard from Reuters.

 

So, what will happen to the oil price?

One thing clear is that it is nearing its low and is going to rise again.

As has been suggested by our analysis, all four factors are institutional. That is, they are long-term factors.

They are all global factors and not to be cleared shortly through geopolitical dynamics.

Therefore, chances are that lower oil prices are here to remain for a while.