The reason oil could drop as low as $20 per barrel

Updated 20 December 2014

The reason oil could drop as low as $20 per barrel

LONDON: How low can it go — and how long will it last? The 50 percent slump in oil prices raises both those questions and while nobody can confidently answer the first question (I will try to in a moment), the second is pretty easy.
Low oil prices will last long enough for one of two events to happen. The first possibility, the one most traders and analysts seem to expect, is that Saudi Arabia will strengthen OPEC's power once it achieves the true geopolitical or economic objectives that spurred it to trigger the slump. The second possibility, one I wrote about two weeks ago, is that the global oil market will move toward normal competitive conditions in which prices are set by the marginal production costs, rather than OPEC's domination. This may seem like a far-fetched scenario, but it is more or less how the oil market worked for two decades from 1986 to 2004.
Whichever outcome finally puts a floor under prices, we can be confident that the process will take a long time to unfold. It is inconceivable that just a few months of falling prices will be enough time for Gulf exporters to reverse the growth of shale oil production in the United States. It is equally inconceivable that the oil market could quickly transition from OPEC domination to a normal competitive one. The many bullish oil investors who still expect prices to rebound quickly to their pre-slump trading range are likely to be disappointed. The best that oil bulls can hope for is that a new, and substantially lower, trading range may be established as the multi-year battles over Middle East dominance and oil-market share play out.
The key question is whether the present price of around $55 will prove closer to the floor or the ceiling of this new range. The history of inflation-adjusted oil prices, deflated by the US Consumer Price Index, offers some intriguing hints. The 40 years since OPEC first flexed its muscles in 1974 can be divided into three distinct periods. From 1974 to 1985, West Texas Intermediate, the US benchmark, fluctuated between $48 and $120 in today's money. From 1986 to 2004, the price ranged from $21 to $48 (apart from two brief aberrations during the 1998 Russian crisis and the 1991 war in Iraq). And from 2005 until this year, oil has again traded in its 1974 to 1985 range of roughly $50 to $120, apart from two very brief spikes in the 2008-09 financial crisis.
What makes these three periods significant is that the trading range of the past 10 years was very similar to the 1974-85 first decade of OPEC domination, but the 19 years from 1986 to 2004 represented a totally different regime. It seems plausible that the difference between these two regimes can be explained by the breakdown of OPEC power in 1985 and the shift from monopolistic to competitive pricing for the next 20 years, followed by the restoration of monopoly pricing in 2005 as OPEC took advantage of surging Chinese demand.
In view of this history, the demarcation line between the monopolistic and competitive regimes at a little below $50 a barrel seems a reasonable estimate of where one boundary of the new long-term trading range might end up. But will $50 be a floor or a ceiling for the oil price in the years ahead?
There are several reasons to expect a new trading range as low as $20 to $50, as in the period from 1986 to 2004. Technological and environmental pressures are reducing long-term oil demand and threatening to turn much of the high-cost oil outside the Middle East into a "stranded asset" similar to the earth's vast unwanted coal reserves. Additional pressures for low oil prices in the long term include the possible lifting of sanctions on Iran and Russia and the ending of civil wars in Iraq and Libya, which between them would release additional oil reserves to the world markets.
The US shale revolution is perhaps the strongest argument for a return to competitive pricing instead of the OPEC-dominated monopoly regimes of 1974-85 and 2005-14. Although shale oil is relatively costly, production can be turned on and off much more easily — and cheaply — than from conventional oilfields. This means that shale prospectors should now be the "swing producers" in global oil markets. In a truly competitive market,low-cost producers would always be pumping at maximum output, while shale shuts off when demand is weak and ramps up when demand is strong. This competitive logic suggests that marginal costs of US shale oil, generally estimated at $40 to $50, should in the future be a ceiling for global oil prices, not a floor.
On the other hand, there are also good arguments for OPEC-monopoly pricing of $50 to $120 to be re-established once markets test the bottom of this range. OPEC members have a strong interest in preventing a return to competitive pricing and could learn to function again as an effective organization. Although price-fixing becomes more difficult as US producers increase market share, OPEC could try to impose pricing "discipline" if it can knock out many US shale producers next year. The macro-economic impact of low oil prices on global growth could help this effort by boosting economic activity and energy demand.
So which of these arguments will prove right: The bearish case for a $20 to $50 trading-range based on competitive market pricing? Or the bullish one for $50 to $120 based on resumed OPEC dominance?
Ask me again once the price of oil has fallen to $50 — and stayed there for a year or so.

— Anatole Kaletsky is an award-winning journalist and financial economist. The opinions expressed here are those of the author.


Riyadh property market swells as mortgages surge 250%

Updated 39 min 39 sec ago

Riyadh property market swells as mortgages surge 250%

  • Vision 2030 economic reforms and major infrastructure projects encourage investment into capital’s real estate sector

LONDON: Riyadh recorded a 250 percent jump in mortgages last year as the value and number of property deals surged in the Saudi capital.

The volume of real estate transactions rose by 53 percent in 2019 compared to a year earlier while the value of transactions was up 63 percent according to a report from broker CBRE.

“The recent economic and social initiatives and legislation introduced by the Saudi Government have already had an extremely positive impact on the country’s real estate sector,” said Simon Townsend, head of strategic advisory at CBRE MENAT. “We are already starting to witness impressive growth across major real estate segments including residential, hospitality and retail, and this upwards trajectory is likely to continue in the short to medium term.”

Ongoing economic reforms under the Vision 2030 initiative have encouraged investment into the real estate sector while spending on major infrastructure projects such as the Riyadh Metro and tourism developments on the Red Sea coast have helped to boost confidence despite oversupply concerns.

“Overall, the country is making great leaps in its efforts to become a global business hub and world-class tourism destination, and the market is expected to continue to react positively to the efforts of the public and private sectors alike,” added Townsend.

Residential mortgages for individuals in the Kingdom recorded a growth rate of more than 250 percent in terms of the number of contracts signed from January 2019 — November 2019, according to the CBRE data. The value of contracts rose by more than 160 percent in the same period year-on-year. 

FASTFACT

At the end of last year, the capital’s residential supply stood at 1,290,000 residential units with an expected delivery of 111,000 additional units by 2023.

In October 2019, the Ministry of Housing launched an initiative to support residential renovations by providing financing for residential units more than 15 years old which is expected to result in higher activity among existing aging stock within the central districts of Riyadh.

Beneficiaries of the Saudi Ministry of Housing’s ‘Sakani’ initiative aimed at increasing the national rate of home ownership, grew by about 14 percent in 2019.

At the end of last year, the capital’s residential supply stood at 1,290,000 residential units with an expected delivery of 111,000 additional units by 2023, CBRE said.

Hotel occupancy is also on the rise in the capital and is expected to receive a further boost from Saudi Arabia hosting the G20 summit this year.

The opening of Qiddiya entertainment giga project which is scheduled for 2023 is also expected to benefit the tourism sector.

There are currently about 17,700 hotel rooms in Riyadh with another 4,500 expected to enter the market by 2023. Hotel occupancy has risen by 5 percent year-on-year, CBRE said.