The price of oil has been subject to some dramatic changes this year, with July seeing the price of a barrel of Brent crude oil reach the historic high of $147. This was short-lived, however, and in September the price dropped to $92 per barrel in response to troubles in the economy with the price continuing to fall and going below $60 per barrel. This may be good news for motorists but it is bad news for UK oil companies already affected by the financial squeeze of the credit crunch.

The fact that oil prices have more than halved since July, in response to decreased demand, means that UK oil companies have less money available to invest in exploration and production projects. The profit gained from extracting oil from difficult locations may not be sufficient to make such projects worthwhile. This could in time have long term effects on the security of oil supplies in the UK continental shelf (UKCS).

Furthermore, the share price of smaller oil companies is much more dependent on the fluctuations in the price of oil than that of larger more established companies. Small companies could be squeezed out of the market. The current climate may also force some to consolidate in order to survive and leave others vulnerable to takeover bids.

Current outlook for the oil industry:

UK – Oil companies in the UK are facing a period of uncertainty. It is not clear how long the credit crunch will continue or how bad things will get. The energy industry is likely to see consolidation of smaller companies in their attempts to survive and it remains to be seen whether the larger players will take opportunities to buy up assets at a knock-down price or whether they will cut back on spending until the future of the economy becomes a little clearer.

US – The US is in the eye of the financial storm. Record low share prices have hit the energy industry in a similar way to other business sectors. Smaller players have found it difficult to finance exploration and production spending and there have been reports of spending cutbacks.

Norway – The Oslo Stock Exchange is especially vulnerable to fluctuations in oil prices. Norway has a relatively large number of new oil companies which may be vulnerable to takeover if the economic downturn becomes too great to bear. Several of the smaller drilling companies have already been taken over. The economic slowdown has also had an impact on the latest licensing round in Norway, with the Energy Ministry requesting more detailed financial information from applicants.

Asia – The fall in oil prices was good news for countries such as India and China which import large amounts of the commodity. This helped to lower inflation and to increase the profits of oil refiners. China's economy has been doing relatively well. However, there are fears that a decrease in exports as a result of the global slowdown could hinder economic growth. Concerns about a global recession have led to a fall in the share prices of Chinese oil companies.

In response to the falling oil price, the Organisation of Petroleum Exporting Countries (OPEC) held an emergency meeting on 24th October. The cartel agreed to cut production by around 5% (1.5million barrels a day).

OPEC has 13 members including Iran, Venezuela, the United Arab Emirates and Iraq. Member countries rely heavily on oil for the stability of their economies. It has been reported that Iran and Venezuela are unable to make a profit from the production of oil at the current price.

By restricting supplies of oil, OPEC aims to create greater demand, which it hopes will in turn push up prices. OPEC does have considerable power - its member countries produce about 45% of the world's crude oil and 55% of the oil that is traded internationally. Decisions made by this organisation should therefore have a global impact.

Responses to this development have been mixed. Early reports stated that the announcement has had little impact on oil prices. However, production was not due to be curtailed until 1st November. Even if oil prices do increase to the satisfaction of oil producers, there are fears that this may have a detrimental effect on the rest of the economy as lower oil prices are said to reduce the pressure of inflation.

Moreover, if prices increase too much in response to decreased production, this may stifle demand, the very reason why the cutbacks were deemed necessary by OPEC. Gordon Brown has expressed his disappointment about OPEC's decision, having previously called the suggestion "absolutely scandalous", making clear his disapproval of the attempted price manipulation. The effectiveness of OPEC's cutback is uncertain given the possibility of non-compliance by its members, yet even if the move does have the desired effect on oil prices, it remains to be seen whether this will do anything to alleviate the impact of the credit crunch. We will just have to wait and see whether OPEC is indeed coming to the rescue of troubled companies or whether it is more concerned with serving the interests of its members.

04 November 2008

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