If you want some perspective into the significance of declining oil prices, look no further than ExxonMobil's annual energy outlook, which was released on Dec. 9. The report is a long-view analysis to the year 2040, and it forecasts that North America will become a net exporter of oil and natural gas by 2020 and that global demand for energy will increase 35% by 2040.
Obviously, Exxon isn't ready to throw in the towel because of temporary low oil prices.
Short-term changes in the price of oil are considered the norm due to fluctuating supply-and-demand conditions. Anyone who has been in the petroleum business for more than a few years is familiar with the cyclical natural of the industry. Smarter companies prepare for the down cycles.
The current oversupply situation was created by the addition of significant amounts of North American crude oil, primarily from shale formations, that has been added to the global oil market. Although US crude exports are still limited, increased domestic production has had the effect of reducing oil imports, which are sold elsewhere.
Saudi Arabia and the other OPEC countries historically have adjusted their production levels to prevent prices from sinking too low, but this time the cartel declined to do so at its Nov. 27 meeting in Vienna. As expected, that caused oil prices to plummet even more and to cause a mild panic on Wall Street as many energy company stock prices dropped precipitously.
Global economies from Europe to Asia are stuck in neutral right now, so demand for energy is down at present. Exxon's outlook and other forecasts show this as a mere blip in the larger scheme. The Irving, Texas-based energy giant says the middle class will grow from two billion in 2010 to nearly five billion by 2030. Most of that growth will come from China and India, which will have insatiable appetites for energy in all forms. Exxon believes that fossil fuels will continue to meet about 75% of the world's energy demand. They and other North American producers are confident that advances in drilling and production technology will place them in an advantageous position as a supplier of global energy needs.
Nevertheless, there is reason for short-term concern about the damage that can be done due to oversupply and stagnant demand. Standard & Poor's Ratings Services just issued a report about the effect of lower oil prices on credit quality of US corporations in 2015. The report concludes that cheaper energy costs will support modest revenue growth among most US corporations, including retailers, airlines, auto manufacturers, and the transportation industry. However, the sharp decline in oil prices will negatively weigh on the energy sector, most notably oil and gas service providers and producers.
"We expect US corporate ratings to remain generally stable in 2015, but the risks to our outlook are increasing," said S&P credit analyst David Tesher. "Historically high speculative-grade leverage, a significant amount of lower-rated debt, and high stock market valuations have elevated systemic risk in the US financial system and increased its exposure to external contagion."
Speaking at a recent Platts Global Energy Outlook Forum, Vitol Group CEO Ian Taylor said that the sudden decline in oil prices should not have been unexpected.
"A fall in price should not have been a significant surprise to anyone monitoring underlying demand and supply, both of which responded to the signals sent by a market in which the price of oil was $100 a barrel," said the Vitol chief. Taylor, who began his career in 1978 at Shell, cautioned the audience that multiple, unpredictable factors can distort or exacerbate prices.
"For someone like me, who sold oil at $5 a barrel and bought at $140, $60 to $70 seems quite reasonable," he said jokingly. "For others ... it may take some getting used to."
Taylor concluded his remarks by saying that the future of global oil markets is "difficult, complex, and uncertain," and will be shaped by changes in energy regulation and policy as well as by OPEC decisions.
It's not just US oil producers who are affected by low crude prices. The Council for Foreign Relations says low prices pose a significant risk to Mexico as well. A recent CFR report notes that the Mexican federal budget, which is heavily dependent on oil revenues accrued through the national oil company, Pemex, is especially vulnerable. About a third of the budget comes from oil revenues. Sustained low prices over several years could force the government to take on new debt, raise revenues, or cut spending dramatically.
Neither are the Saudis immune to sinking oil prices. The S&P report notes that Saudi Arabia, with its "undiversified" economy, remains exposed to economic risk due to its heavy dependence on revenues from oil exports. Hydrocarbons account for about 44% of the country's GDP. About 80% of exports and 90% of government revenues stem directly from the hydrocarbon sector, says S&P.
Low oil prices or not, you won't see Saudi Arabia or ExxonMobil reducing their investment in hydrocarbons. Both petroleum behemoths are aware that global energy demand will increase, not decrease, over the next few decades. Temporary cyclical price changes do not affect their long-term thinking.