Global commodity prices have plummeted over the past few months. Iron ore prices for example, are near ten-year lows; having reached close to US$200 per tonne in 2011, the value was a mere US$39.25 per tonne on Wednesday.

Crude oil prices have also continued a downward trend, driven by a lingering imbalance ― excess of supply over demand ― estimated to be more than 2 million barrels per day (bpd). In the aftermath of the 168^th meeting on December 4, of the Conference of the Organization of the Petroleum Exporting Countries, OPEC, crude oil prices closed at near seven-year lows. At that meeting, OPEC resolved not to reduce crude oil output. On Monday (7 December 2015), the international benchmark Brent closed at US$39.69 per barrel and West Texas Intermediate, at US$37.65 per barrel.

The current supply overhang grew largely from the massive production ramp-up in unconventionals, mainly in the United States (shale) and to some extent, Canada (oil sands).

In what was termed a sheikh-versus-shale duel, OPEC, particularly the Gulf States led by Saudi Arabia, sought to rein in those higher-cost producers by increasing output to drive down prices and retain, if not gain market share.

Mission Accomplished

That OPEC strategy is seemingly yielding intended results. The International Energy Agency, IEA, reports that non-OPEC oil supply which was growing at the rate of 2.2 million bpd at the beginning of the year, had fallen to just 300,000 bpd in November.  Growth is expected to vanish completely by 2016 due mainly to declining U.S. shale production. According to the Energy Information Administration (EIA), total U.S. crude oil production fell 500,000 bpd between April and November 2015.

The impact of OPEC’s decision on the global oil and gas industry has been significant. With many large-scale projects either cancelled or deferred, capital expenditure declined by 20% in 2015 and is expected to fall an additional 11% in 2016, according to Evercore ISI. As cost-cutting measures, oil and gas as well as oil services companies have laid off a sizeable number of staff and divested billions of dollars worth of assets. In parts of the North American oil patch, once-bustling communities have become near ghost towns.

OPEC may have succeeded somewhat in reining in the shale boom, but that has come at a huge cost. The IEA projects OPEC revenues to slump to US$400 billion this year, down from US$1.2 trillion in 2012. Many OPEC nations depend on crude oil sales for significant proportions of their foreign exchange earnings and the collapse in prices has come with huge financial burden. Nigeria, for example, depends on crude oil for more than 80% of foreign exchange earnings and the price slump has meant that many state governments are unable to pay workers’ salaries or execute some capital projects; and there may yet be fresh troubles ahead for the country.

The case of Venezuela is even more telling; with crude oil accounting for about 95% of its export revenue, the country is currently in dire financial straits. While the government has forecast inflation rates of 85% and 60% for 2015 and 2016 respectively, independent analysts believe realistic rates are much higher.

Sovereign Wealth Funds (SWFs), particularly those funded from petroleum assets have not escaped the oil price rout. According to Financial Times, SWFs in the Persian Gulf have withdrawn funds from asset managers at a record rate this year, with OPEC giant, Saudi Arabia, which has seen widening deficits pulling tens of billions of dollars from asset managers. As reported by Reuters:

Data provider eVestment said state investors have removed at least $19 billion from funds under management, sparking both concerns that profits for investment managers will suffer, as well as further losses to funds under management… The Saudi Arabian Monetary Agency is one of the sovereign wealth funds that has made withdrawals from its asset managers… the fund, with more than $650 billion in assets has withdrawn around $70 billion.

Outlook

According to data from OPEC, the exporter group pumped more crude oil (31.695 mbpd) in November than in any month in the last three years.

That meeting of the Conference of OPEC, which held last week, ended rather acrimoniously. In what may determine the group’s future, the long-simmering ideological and other differences between two of its largest producers, Saudi Arabia and Iran, found expression over output quotas. Iran, which is revving to unleash about 1 million bpd of crude oil into the global stock following the expected lifting of sanctions, may find the Saudis, equally eager to retain market share, unlocking the taps to her massive spare capacity. The result would be a widening of the already outsized global oil imbalance.

The situation could be exacerbated by Russia’s resolve to increase her oil output. Buffeted by sanctions in the aftermath of her invasion of Crimea, the country’s currency, the rouble has slipped against a strengthening U.S. dollar. This has made her production cheaper while increasing her revenue from the dollar-denominated commodity. In addition to the current economics of oil supply, the country would find no incentive to reduce output. It is however, doubtful if that country can endure a low oil price regime. The economy is already in recession and according to Standard & Poor’s, the budget deficit has reached 4.4% of GDP. With asphyxiating western sanctions firmly in place, borrowing from international agencies would be hard to achieve.

A countervailing force to the current output trend would be Rystad Energy’s estimate of between 1mbpd and 1.5mbpd of output decline in mature fields around the world over the next 12 months. The decline rates, which are about twice empirical values, are attributed to underinvestment ― due to the current low oil price regime ― in the combat of natural decline. In addition, China, one of the world’s highest energy consumers has seen its economic growth rate slow significantly.

With a record global inventory of about 3 billion barrels and a widening imbalance, oil prices would most likely remain low in the near term. Traders that had bet on oil contango have come to rethink their positions, adding further downward forces on oil prices; and uncertainties associated with the current state of the global economy, only add to price volatility.