The Big Drop: Causes and Consequences

Rabah Arezki (IMF)

Ben Hunt (IMF) Akito Matsumoto (IMF)

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Disclaimer: This presentation should not be reported as representing the views of the IMF. The views expressed in this presentation are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. The presentation describe research in progress by the author(s) and are published to elicit comments and to further debate

(Crude) oil prices have slumped

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1204-year ahead futures Spot price

Brent ($ per barrel)

1. What causes?

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Main lessons Consequences depend on causes • Supply or demand

– Supply driven decline >Positive – Oil specific demand > Positive – (Aggregate) Demand drive decline >Offsetting

• Persistence and dynamics affect consequence Causes: • Demand and supply have both played a role in

the price drop, but supply a bigger role; • Changed behavior of Saudi has changed

expectations about supply dynamics; 4

Aggregate demand helped explain fluctuations in oil prices. Not this time.

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Global Economic and Market Conditions (unit free) APSP (HP Filtered, RHS)

Other commodity prices have declined

but much more gradually • Metal prices typically

track aggregate demand as well.

• The decline in metal prices is much less pronounced than for crude oil prices.

=> Supply factors behind the oil price slump?

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Metals Food Energy

IMF Commodity Price Indices (2005=100)

Mar. 2015

Source: IMF, Primary Commodity Price System.

Demand “Surprises” • What were the changes

in demand over the second half of 2014 and where do we stand now?

• Forecast errors (1mb/d) imply a 10-20% in the price decline.

• That is roughly 30% of price changes . 0.0

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IEA Forecast of World Oil Demand Growth Year on Year

February 2015July 2014September 2014October 2014December 2014

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Supply “Surprises” • Non-OPEC supply

surprises are about 1 mb/d for 2014Q3 slightly less for Q4.

• OPEC supply surprise –Iraq and Libya 0.5-1.5 mb/d ?

• Supply factors seem to have played a bigger role than demand. 0.0

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IEA Forecast of Non-OPEC Oil Supply Growth Year on Year

July 2014

November 2014

February 2015

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OPEC Reaction (or lack thereof)

• OPEC typically adjusted to targets to stabilize prices.

• This time is different? But why?

• Learned lessons from 1980s?

• Erosion of cartel discipline? 0

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OPEC Crude Production and Target

Production

Target

APSP (RHS)

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OPEC/Saudi Arabia: Shifting Strategy?

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PROSPECTS AND CONSEQUENCES

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Outlook and Consequences Outlook: future supply behavior is key, but very

uncertain • How will oil supply respond to lower prices?

– In past, response has been with a lag. – What happen if the efficiency gains are strong and

investment drop further? Cobweb? • What will Saudi/OPEC do? Future demand: 1% growth forever? • Downward shift of potential GDP growth • Efficiency gains/ Energy policy

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Contango and Increase in Uncertainty

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Latest October 2014 WEOJuly 2014 Update April 2014 WEOApril 2015 WEO

Brent Futures Curves, April 2015 (U.S. dollar a barrel)

Source: Bloomberg L.P.

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Brent Oil Price Prospects 1/ (U.S. dollars a barrel)

95% confidence interval86% confidence interval68% confidence intervalFutures

Sources: Bloomberg; and IMF staff calculations. 1/ Derived from prices of futures options on April 24, 2015.

Global Economy • Net positive

– Propensity – Reduced rent for oil

producers • Winner: net importers

– Pass-through – Government, firms,

households • Loser: net exporters

– Income loss – Oil Investments

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2014 2015 2016 2017 2018 2019 2020

Increase in OIl Production

"+ Impact of Oil Subsidy

Global GDP (excluding Other Oil Exporters) (% Difference)

Real Income Effect

Oil Production, Consumption and Investment for Selected Countries (in percent of GDP)

Production Consumption Investment Norway 11.1 1.8 4.5 Japan 0.0 3.7 0.0 Netherlands 0.1 4.2 0.0 United States 1.6 4.5 0.7 China 1.7 4.5 0.4 Canada 7.2 5.1 2.7 Qatar 14.4 5.2 0.4 Russia 18.9 6.3 1.7 United Arab Emirates 27.3 7.6 2.1 Kuwait 57.4 11.1 1.6 Thailand 1.5 12.4 0.4 Turkmenistan 17.1 13.2 2.1 Venezuela 43.0 14.1 2.8 Saudi Arabia 49.5 16.4 0.5 Iran 28.4 20.6 1.7 Sources: BP Statistical Review of World Energy; Rystad Energy research and analysis; and IMF staff calculations.

OIL SECTOR

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Non OPEC Investment (billions of U.S. dollars)OPEC Investment (billions of U.S. dollars)OPEC Production (mbd, RHS)Non OPEC Production (mbd, RHS)Total Production (mbd, RHS)

OPEC and Non OPEC Oil Production and

Source: Rystad Energy research and analysis.

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Investment and Production in Oil Sector

• Investment activity declines quickly in response to oil price decline.

• Oil production gradually decline over time in response to oil investment.

• The current future prices indicate stagnant oil production.

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Operating cost (U.S. dollar per barrel)Oil Production (mbd) [RHS]

Oil Production and Operating Cost by Country

Source: Rystad Energy research and analysis.

Investment Declines Quickly but Production Slow

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Perc

ent c

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coefficient

90 percent confidence interval

Response of Oil Investment to Oil Prices

Source: IMF staff estimates. Notes: The chart show the deviation of oil investment from trend in response to the change of oil prices. The computed cumulative response is based on the regression of the logarithm of the first difference in oil investment onto the distributed lags (10) of the logarithm of the first difference in oil prices after controlling for country fixed effects

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Perc

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coefficient

90 percentconfidence interval

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Response of Oil Production to Oil Investment

Source: IMF staff estimates. Notes: The chart show the deviation of oil production from trend in response to the change of oil investment. The computed cumulative response is based on the regression of the logarithm of the first difference in oil production onto the distributed lags (10) of the logarithm of the first difference in oil investment after controlling for country fixed effects.

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Weekly Rig Count

WTI Rig Count

(notes) Annual Changes in percentage. Oil rig counts from Baker Hughes Inc. WTI spot prices from Datastream.

Oil Sands and Deep Water would be Most Affected

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But not the big shale plays

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