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localnomics

Why oil prices plunged today and could keep falling

Oil prices plummeted today after reports of a two-week halt to protests that have blocked Libyan crude exports, and an economic slowdown in China. The plunge reflects the primary role of local politics and economics—in China, Libya, Nigeria, Iran and elsewhere beyond—in determining oil prices. It also rekindles the longstanding debate over whether we’re in an age of oil abundance or scarcity.

The debate goes like this: Last year was supposed to initiate a long slide in oil prices lasting through the end of the decade and beyond, according to many forecasters, driven largely by a surge in US oil production to 7.7 million barrels a day as of October. But an outbreak of local and geopolitical trouble (such as the increased theft of Nigerian oil, pictured above) shut off about 3.5 million barrels of global supply, led traders to keep global prices above $100 a barrel–and provided ammunition for opposing forecasters who believe in oil scarcity.

Until today, that is, when protesters at Libya’s Al-Sharara field said they will lift a two-month-old blockade of 350,000 barrels a day of production after promises of a greater say in government decisions. In addition, a widely watched HSBC index showed that Chinese manufacturing barely grew in December, its slowest rate in three months. And the new year began with the perception of a “U.S. better supplied with oil than at any time in history,” Phil Flynn, an analyst with the Price Futures Group, wrote on his blog.

As a result, international benchmark Brent crude plummeted by 2.7%, to $107.78 a barrel. The US-traded benchmark was down 3% to $95.44 a barrel, its lowest price in months.

The price decline boosts those who argue that oil abundance will bring on a decade-long period of relatively low oil prices. Among the leaders of this group is Citi’s Edward Morse, who forecasts (pdf) oil prices averaging $80 a barrel through 2020 and beyond.

But an equally fervent if less vocal group of analysts say that while appearances have changed, the global oil market has not; supplies remain tight and oil prices are on the way up, they say. In a note to clients today, Oswald Clint’s research group at Sanford Bernstein forecasts almost double Morse’s oil price estimate—$158 a barrel in 2020.

Bernstein’s arguments, among others, are that the US surge will be less than many expect, that global demand will surpass supply growth, and that OPEC nations can’t subsist at sub-$100-a-barrel and will cut production to hold that as a price bottom.

Citi forecasts $98-per-barrel Brent in 2014, down from an average of $108.71 last year; Bernstein says prices will average $110. They are the extremes: A Bloomberg survey of last year’s most-accurate oil forecasters produced a prediction of $105 a barrel in 2014.

As today’s price plunge shows, the answer will be much less mysterious than these forecasts make it seem. As with 2013, it will boil down to local and global politics: If the US and Iran harden their November deal with a nuclear settlement that lifts sanctions, that alone should send prices down—not because new Iranian oil supplies will flow immediately onto the market (it will take time), but because of the chances for a period of lower tensions. If you get that and a political agreement among tribes and clans in Libya, resulting in a full resumption of its 1.6 million barrels of supply, Ed Morse will deserve a handshake.

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