By Masashi Amano / Yomiuri Shimbun Economic News EditorDespite production cuts by oil-producing nations, crude oil prices have basically failed to rise. Will this enigmatic market situation continue? The keys to deciphering its direction are the three Rs: revolution, rate of interest and rupture.
The first R: Revolution
“We hear the victory song of revolution,” said one oil trader of current crude oil prices.
Oil producers such as members of the Organization of Petroleum Exporting Countries (OPEC) and Russia decided in May to extend oil production cuts until March 2018. The cuts were originally slated to last from the beginning of the year until June.
The measure was aimed at buoying crude oil prices by curbing production.
The international benchmark West Texas Intermediate (WTI) prices, however, are hovering around $45 a barrel — about 10 percent lower than before the production cuts began.
Continued increases in shale oil (see below) production in the United States, which is not taking part in the production cuts, is one factor.
Starting in January this year, OPEC has aimed to cut production by 1.2 million barrels a day.
But even within OPEC, three nations have been exempted from the cuts — Nigeria and Libya, because of political instability, and Iran, because it aims to recover its market share following the lifting of economic sanctions. These three have increased production by approximately 500,000 barrels.
Additionally, U.S. shale has boosted production by about 400,000 barrels, weakening the effects of OPEC’s output cut.
Since 2010, the United States has increased shale oil production by 4 million barrels per day, an amount roughly equivalent to Iran’s oil production.
Shale has catapulted the United States to a position alongside Saudi Arabia as one of the largest oil producers, and brought the first R, revolution, to the world’s oil market.
The U.S. Energy Information Administration forecasts that production of shale oil and others will reach 5.58 million barrels a day in August, a record high level.
Lower break-even prices and the stance of the administration of U.S. President Donald Trump are seen to contribute to production increases.
Shale once required prices of about $70 a barrel to break even. But as a result of technological innovation, the break-even point has dropped to around $40, making it profitable even at low prices.
After deciding to withdraw from the Paris climate change agreement, the U.S. administration is moving to relax environmental regulations and expand domestic resource development.
Steps to accelerate approvals for oil and gas exploration on public land are already underway.
Trump also has a positive view of efforts to use domestic shale oil and natural gas to shift the United States from a resource importer to a resource exporter.
Natural gas exports to Poland began in June. Poland is dependent on Russia for much of its gas imports, and the move is seen as a way to check Russia’s aggressive resource exports in Eastern Europe.
The victory song of the shale revolution is still being sung, and will likely continue to put downward pressure on crude oil prices.
The second R: Rate of interest
When considering oil prices, the effects of interest rates cannot be ignored.
In addition to those who need oil, many investors participate in the market, bringing enormous speculative investments. WTI production is about 300,000 barrels a day, but with the addition of futures transactions, actual trading balloons to about 1 billion barrels a day.
As a result, crude oil prices are strongly susceptible to movements in the financial markets, in addition to pressure from supply and demand. Because transactions are conducted in dollars, they are especially sensitive to U.S. interest rates.
When the U.S. Federal Reserve Board begins seriously considering rate hikes and interest rates rise, a downward trend is seen in oil prices.
When rates rise and the dollar grows stronger, it costs more to procure dollars to buy crude oil.
It is thought that speculators expecting further rate hikes are driven away from costly crude oil to other investment products, leading to lower crude oil prices.
At the Federal Open Market Committee meeting on July 26, the Fed decided to continue its current policies toward raising interest rates. For the moment, the anticipation of higher interest rates weighing down higher prices for crude oil is unlikely to change.
The third R: Rupture
A rupture also serves as a factor that pushes prices downward.
Saudi Arabia cut diplomatic ties with fellow OPEC member Qatar in June. The move was aimed at deterring Qatar from deepening its ties with Iran, a nation at odds with Saudi Arabia.
A worsening situation in the Middle East generally pushes crude oil prices upward. But this time, while prices rose immediately following the announcement of severed relations, they soon turned downward.
This is due to concern that the turmoil within OPEC may endanger the continuation of production cuts.
On top of a protracted rupture in relations, if dissatisfaction with the lackluster effects of production cuts leads Russia to end the coordinated cuts, market fears could amplify and prices could further decrease.
Saudi Arabia announced a policy to limit its own crude oil exports in an effort to emphasize continued output cuts — which, along with other factors, led to a slight upswing in crude oil prices.
But the three Rs continue to have significant impacts, leading to persistent expectations that crude oil prices will remain in the $40 to $50 per barrel range in the second half of the year and later.
Low crude prices are generally desirable for oil-consuming nations like Japan, but negative aspects cannot be ignored.
Inexpensive crude oil pushes consumer prices down, leading to concerns that it may hinder Japan’s efforts to overcome deflation.
Vigilance is also necessary against the risk that low oil prices may lead to serious financial crises and currency weakness in oil-producing nations, and also trigger chaos in the global economy and financial markets.
There is also a risk that protracted low oil prices may hurt oil company margins and lower investment in the development of new oil fields, for example, leading to a drop in production and a jump in prices.
Japan depends on the Middle East for more than 80 percent of its oil imports. The nation cannot afford to be complacent about the current low crude oil prices and neglect to take steps to prepare for the future.
It is important to take advantage of the low prices in the current buyer’s market, to gain advantageous purchase conditions through tenacious negotiation. Increasing resource imports from countries like the United States and Russia is another approach to consider.
Winston Churchill, the British prime minister during World War II, served as First Lord of the Admiralty in the 1910s. To prepare against the German threat, he led the conversion of the British fleet from coal to oil power — the catalyst said to have made the 20th century the “century of oil.”
“Safety and certainty in oil lie in variety and variety alone,” Churchill once said. It is a truth that applies to contemporary Japan as well.
■ Shale oil
Crude oil located in the hard bedrock known as shale 2,000 meters below ground. It used to be difficult to extract due to high costs. New technology that involves making cracks in this rock using high-pressure water has been developed, and the United States and Canada have increased production in the 2010s.Speech