In July 2008, oil reached a new peak of $145/barrel, driven by rising demand in China and speculation that continued global economic expansion would push prices ever higher. Yet when the financial crash hit, the oil price went into freefall, and by December that same year the spot price stood at $30.28.
Wild price fluctuations
Oil prices recovered well over the next few years, but the experience had been a warning of things to come, demonstrating how oil and gas companies were at the mercy of wild market fluctuations. Yet the industry had failed to learn its lesson, and when prices crashed again, plummeting 50% in the second half of 2014, many operators were once again left exposed. And this time, there came the realisation that this was no market blip. Sub-$50 oil was the new reality.
A perfect storm
Initially, many suppliers were protected by hedged positions, and they hoped that prices would recover before their positions unrolled and exposed their businesses to the harsh reality of the market. But what many had hoped was merely a squall, turned into a perfect storm. As economic output in China began to cool, both real demand and speculative demand melted away. While the removal of economic sanctions on Iran paved the way for the re-entry of another large-scale supplier, adding to the challenge of over-supply.
Analysts are now warning that the lows of 2008 could once again become a reality. Indeed, a recent paper by Deloitte has mooted that if US storage plants reach capacity, this will remove the buffer that dampens the effects of increased supply, making it a genuine possibility that prices could plunge below 2008 levels. So in the absence of a major OPEC intervention, rapid acceleration of global economic growth, or a radical change to the geopolitical landscape in the Middle East, it seems likely that oil prices will remain low for at least the next two years.
The challenges for oil & gas firms
So far, the impact on global production has been remarkably slight. But as companies struggle to adjust to this new reality, those suppliers whose business models are unprofitable at sub-$50 may face insolvency, ceasing production and contracting supply. One solution for smaller players may be to seek safety in numbers, and a wave of mergers and acquisitions at the lower end of the market appears a distinct possibility. For the big players, another round of cost-cutting seems inevitable, as they reduce head-count and place increased pressure on service providers and contractors to cut their rates even further.
These are certainly challenging times for everyone in the oil & gas industry. Yet the upside is that those companies that emerge from this process of readjustment will be leaner, fitter and potentially more flexible - better suited to meet the challenges of a rapidly changing global marketplace.
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