Oil Check: What Caused the Oil Market Oversupply?

Oil Market Oversupply and Its Ramifications

Remember how high gas prices were less than a month ago? Now a trip to the pump is far less painful. What happened that pushed the price down, besides another indication that the oil market is ever shifting and far from predictable? Well, in short, oil market oversupply. Oil shifted from $100 a barrel to being depressed. There are a number of contributing factors:

Events that Contributed to Decreasing Oil Prices

1. Iran Sanctions

Over the 180-day run-up to the U.S. imposing sanctions on crude oil from Iran in early November, oil prices edged up over fears of an abrupt supply shortage. Iran is a top-five producer of crude oil, so it was clear other petroleum producing nations would have to fill the gap.

2. Saudi Arabia and Russia Race to Capture Market Share

With the sanctions levied against Iran, customers would be looking for new oil sources. Saudi Arabia and Russia both began to increase production in September in an effort to capture the market share that the sanctions would create. This production would increase crude oil supply and have the added benefit of creating a cushion to absorb the loss of Iranian crude and keep prices stable.

3. U.S. Offers Oil Vouchers

Right before the sanctions took hold, Washington issued six-month vouchers to the top eight countries that purchase Iranian oil, allowing them to keep importing some Iranian crude. As long as these countries are still importing, Iran can continue to export. While they are exporting at lower levels than in 2017, they’re still contributing, resulting in…

4. Global Oil Market Oversupply

Saudi Arabia and Russia essentially caused the oversupply by anticipating Iran would no longer be contributing. Now, instead of gracefully absorbing the shift in crude supply, they duplicated production efforts. The sudden increase in downward pressure on oil prices triggered a bear market. All of this over the course of a couple weeks.

What will happen next with the oil market?

If the market stays oversupplied, oil producers will lose profit and will scale back production. That’s the most obvious conclusion. But there are further complications that could come to light in the future OPEC+ meeting.

The OPEC+ Meeting

OPEC and ideally the Vienna Group (who, together, make OPEC+) are expected to take steps to curb production to help rebalance the global oil market. This was an effective tactic over the course of 2017.

Early Signs of Slowed Oil Production

Saudi Arabia has already announced production cuts beginning in December and is expected to campaign for other nations to follow suit. They’re interested in creating a price floor, a point they don’t want the price of oil to dip below. In an ideal world, they want the price of oil to stay between $70 and $90 per barrel. The global economy would be happier with $80 per barrel. Lower than $70 per barrel may be good news for consumers, but is too low, according to many economists.

Potential Major Producer Hold Out

However, Russia, a top producer of crude, is one player to watch throughout the OPEC+ meeting on December 7. In the November OPEC+ meeting, Russia wanted to defer a production cut decision to the December meeting to see what happened across the global market.

Major Motivation

There could be other geopolitical factors – beyond the interests of OPEC+ – influencing these decisions. There is speculation that Russia is looking to use its dominance in energy as a tool to offset the impact of any additional U.S. sanctions that may be on the horizon. Russia may be anticipating this following Democratic control of the House of Representatives, especially following their recent aggressions toward the Ukraine.

• Fun Fact: In the last oversupply, Saudi Arabia decided to continue producing oil at to capture market share, even at such a low price. The reasoning here was to establish connections that would continue beyond the low prices. Ultimately oil became so cheap Saudi Arabia began to cut back on production, at which point the U.S. softened the impact by increasing its own crude production. Whether this was a winning tactic for Saudi Arabia or not is up for debate, but Russia may be attempting a similar move.

Oil prices will remain at its current low for a number of weeks. But what will happen next? There are several possibilities. Saudi Arabia is pushing for production cuts. On the other hand, Russia may be pushing to take more control of the market share. As soon as we find out the result of the OPEC + meeting, we’ll be sure to share them with you on our blog. Subscribe if you haven’t already, and keep your eyes peeled for the next Oil Check.

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