In a series of articles over the past several months we’ve been discussing various aspects of the energy investing sector. Due to the substantial collapse in oil prices and corresponding decline in energy-related investments, a time is coming when investors will be able to buy these companies at rock-bottom prices. But where is the bottom and how close are we to it?
That’s precisely what we’re about to explore. We’ll begin with a list of the top ten oil producing nations, beginning with 1995. Then, we’ll consider the negative impact that lower oil prices have had on the global economy. Finally, we’ll examine the primary causes for price fluctuations, which will lead us to where oil prices may be heading.
So whether you’ve already invested in the energy sector or you’re planning to, follow along as we discuss these critical, energy-centric issues.
Global Oil Production
A large number of countries are involved in the extraction of crude oil. Because many of them are not close allies, and due to the competitive nature of the industry, it would be impossible to expect some sort of equilibrium with respect to supply and demand. The Periodic Table of Oil Production below lists the top ten oil producing nations for each year from 1995 to 2014. Here are a few observations.
- The top three countries have been the same during the entire period, the U.S. being among them.
- Saudi Arabia was the top-producing country for the majority of these years (13 out of 20) and it also holds 16% of the world’s proved oil reserves according to the U.S. Energy Information Administration (EIA). This is one reason the U.S. needs to remain on friendly terms with the Saudis.
- The vast majority of the countries on the top 10 list are small, emerging economies (75%). The only developed economies on the list are the U.S., Canada, and Norway.
- Iran was consistently the fourth largest producer until 2010 when it began to lose ground thanks to economic sanctions, which will soon be lifted.
- Mexico was in the top half of the table until 2005 when it began to fall. Last year it ranked number 10, barely surpassing Kuwait and Venezuela.
- Canada’s rise has been the most consistent.
- China and the United Arab Emirates (UAE) have been gaining ground.
It’s interesting to note how the bottom seven countries have changed positions over the years. Norway dropped out of the top 10 in 2007 and Venezuela in 2012. Brazil, Iraq, and Kuwait have moved in and out of the top 10 list during this period. Now let’s look at the global effect of lower oil prices.
The Crude Collapse: The Effect on the Global Financial System
The collapse in crude is a detriment to any nation for which oil is a major source of revenue. Since most of the top producers are emerging countries, the economic shock is potentially great. Saudi Arabia seems to be steady. But Russia’s economy is contracting and its inflation rate is approaching 16%. According to the EIA, income from oil and natural gas production and exports accounts for more than half of Russia’s federal budget revenue (Link to data: EIA).
China’s economy is also slowing as government infrastructure projects have slowed and exports have declined. This is a key reason China has been devaluing its currency. The following table contains financial market performance for emerging markets.
Notice how poorly Latin America has performed. Even emerging market bonds are struggling. Clearly, many smaller countries have been hurt from a decrease in oil prices and the resulting revenue from exports.
Oil Price Catalysts
Oil price fluctuations are based on a number of factors. Here are five primary catalysts:
1) Supply and demand
3) Civil unrest in oil-producing nations or along transportation routes
4) Political decisions (e.g., adverse tax treatment and regulations)
5) Natural disasters
Let’s focus on supply and demand.
Prior to the invention of the internal combustion engine oil had limited uses. With the advent of the modern automobile and the development of highway systems, the transportation industry flourished and the popularity of oil increased substantially. Petroleum products also became one of the primary sources of power generation. Today, oil is an essential component of modern life.