Analysis of the Sustainability of Current Global Oil Markets

Analysis of the Sustainability of Current Global Oil Markets

Author Note

This paper was completed in partial fulfillment of MBA 7520 in the spring of 2016.

     In January of 2016 crude oil traded below $30 per barrel, a stark difference from the 2008 price, which reached $140 per barrel (Economist, January 23, 2016). The decline in price has coincided with significant changes in the production landscape. OPEC’s abandonment of output quotas in late 2015 has paved the way for the recent decline in crude oil prices (The Economist, January 16, 2016). With increased production by Iran, significant increases in production by U.S shale producers, and OPEC producers flooding the oil market, it is not surprising that oil inventories around the world have reached their highest level in recent years. U.S. crude oil inventories are currently higher than normal (U.S. Energy Information Administration, 2016).

     According to the U.S. Energy Information Administration recently released forecasts for North Sea Brent crude oil prices are lower than expected in recent reports. As of March 8, 2016 North Sea Brent is estimated to average $34 per barrel, $3 less than expected. Moreover, 2017 estimates are for prices around $40 per barrel, again lower than previous estimates (U.S. Energy Information Administration, 2016).  West Texas Intermediate (WTI) prices are estimated to follow a similar pattern to that of Brent Crude. WTI Crude spot price history is depicted in Figure 1 (U.S. Energy Information Association, March 9, 2016).

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Figure 1. WTI crude oil price history (1986-2016)

Current Market Conditions

     The United States remains the world’s largest producer of oil, even after cutting production by more than 400,000 barrels per day, largely from shale production (The Economist, January 23, 2016). Despite OPEC’s attempt to drive higher-cost shale producers out of the market, U.S. production has remained strong, with production actually rising by 900,000 barrels per day.  A common question arising from the current market landscape is whether U.S. producers can survive if the current market conditions persist. What price is sustainable for smaller shale producers? And how different is their cost structure from that of the major oil companies? In this paper we will discuss recent trends in capital expenditures by some of the major oil companies (e.g. ConocoPhillips, Chevron, Exxon, and BP). We will discuss the role that strategic alliances have in the sustainability of the global market; and we will discuss the Edgeworth Box diagram as a means of understanding how it may make sense for major oil companies such as Exxon Mobil, Chevron, ConocoPhillips, and BP to negotiate long-term purchase agreements for crude oil directly from OPEC at preferred pricing rather than spend billions to develop new projects in remote areas which will ultimately have a higher per barrel cost than direct purchases from lower cost producers, who themselves need access to the retail gasoline market in the United States.  Each party has something the other needs and the Edgeworth Box illustrates the economic rationale for such a deal.  If accomplished this type of transaction offers a new way forward, one that could help to mitigate the brutal price swings, which we have witnessed in the oil market of late.