Yesterday Brent crude dipped below the $50 a barrel mark yesterday. The catastrophic oil price plunge makes lots of investors nervy, as subconsciously they still stick to the pre-crash price, thinking oil is ‘worth’ $100 a barrel, regardless of what logic tells them.
Some of you can recognise this behaviour in yourself. But do not worry too much, as a number of analysts consider there will be big opportunities in the oil sector. And you’ll have plenty of time to pick them up. In the meantime, prices could be falling for a while yet.
The previous oil price crash was completely about global demand. When in late 2008 the credit crunch hit home, oil plunged from a high of nearly $150 a barrel to a low of around $30 in the course of six months. This happened mostly as a result of liquidity being sucked out of every facet of the financial system.
Today's oil price crash is entirely different. Slowing demand – primarily from China – has played a role. But as it was mentioned above, it is more about supply. US shale has added a significant new source of oil, and it has also arguably suffered from over-investment due to cheap-money fuelled enthusiasm.
The most obvious solution seems that the producers should just stop making it. But that’s actually a frivolous question if you think about it.
It’s like saying that Tesco’s best response to the threat from Aldi and Lidl would be to stop selling anything. After all, the grocery market is clearly over-supplied. Knocking out the biggest supermarket chain in Britain would show those greedy, demanding consumers who was boss, eh?
But in reality, of course, it would hand control of the market to Tesco’s rivals, and Tesco would rapidly go bust. The correct long-term strategy is to spend what it takes to slash prices, improve service, and hope your pockets are deep enough and your offer attractive enough to put the other guy out of business. Your shareholders might not be too happy about it – it means falling profits, one way or the other – but that’s what happens when an industry hits a point of chronic oversupply.
Believe it or not, the same logic applies to oil. That is why Saudi Arabia keeps saying "why should we be the ones to cut production?” Why should they give up market share to Russia and US shale and all the other producers, particularly when they are the guys who are best-placed to survive any price war?
Photo: National Geographic
