Oil – Problem of surplus

The engine of the petrol economy is sputtering. Once upon a time, not too long ago the oil producing nations had a great time. A minor cut in production could result in an increase in crude prices. Rapidly growing developing nations as well as strong developed economies were fuelling the demand for crude. By keeping a lid on production of crude, the oil prices were maintained at historically high levels in the region of $100 a barrel. The high was $111.95 a barrel in 1984. As recently as 2013, it hit the record price of $115 per barrel.

“For every action, there is an equal and opposite reaction” is a theory of Physics that kind of applies in Economics too. Seeing the high rate of crude, technological innovations helped bring sub-par reserves into market. Earlier reserves that were not viable due to high cost of recovery were now viable given the high margins. The emergence of Shale gas players. Though it was imperative for developing countries to get cheaper oil to reduce their deficits and promote economic growth, supply controls kept Crude at a high level.

The sanctions on Iran also enabled curb the supply and keep prices high. However, with new players gathering market share, the high price play did not seem to be a good idea. In order to squeeze them out of the market, Saudi Arabia came up with a policy of increasing supply and thereby applying downward pressure to protect market share. The policy worked for a while with new projects being shelved and some existing Shale units shutting down. However, resilient alternative supplies kept pouring in and the supply glut commenced. Countries such as Venezuela and Russia began facing severe problems. The latest speculation is that even the Saudi are facing problems with their budget due to the super low oil price. There are two alternatives out of this situation. One is to cut production and the other is to play around with the exchange rate for the Saudi Riyal that is currently pegged to the USD (1 USD = 3.75 Riyals). Devaluing the Riyal will ease the budgetary pressure.

Meanwhile with the sanctions on Iran removed and existing over production, there have been reports of oil being stored in tankers and containers and any conceivable place. The latest is a deal that was stuck between India and UAE’s ADNOC to store 6 million barrels of crude in India’s strategic reserves as inventory in exchange for allowing India to take 2/3rd or roughly 4 million barrels for its own consumption.

However, here in Canada, we have not seen any significant change in  gas prices at the pump.  While Canadian oil producers are struggling to get pipelines in place to transport crude out, there is a news report that Canada is importing 84,000 barrels of crude daily from Saudi Arabia.

Never saw this coming!

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