Oil price volatility returned with a vengeance in October amid worries of slower economic growth, weakening oil demand, an unexpected increase in Libya’s output and Saudi Arabia’s indication that it would not cut output in the face of weaker oil demand. As this went to press, US oil prices continue to hover just above $80 per barrel for WTI.

The oil price decline is more a reaction to possible future weakness in oil demand rather than a sudden change in supply and demand fundamentals. It is true short term demand is lower than expected, but the longer term outlook remains positive according to Wood Mackenzie's latest analysis.

"Current production in most areas of the world, including US tight oil, is economic well below current oil prices and not likely to be shut, except for a few unusual cases such as US extra heavy and 'stripper' well production," says Ann- Louise Hittle, Head of Macro Oils for Wood Mackenzie.

The following are the key considerations from Wood Mackenzie's analysis:

1. Wood Mackenzie anticipates that the global economy will remain stable in 2015 and support oil demand gains. With demand continuing to grow, the projected strong increase in non-OPEC production can be absorbed in the market without causing further significant price declines.  If market concerns about the economy materialize, prices could fall further as the market moves into an oversupply situation. In a scenario where global demand creeps up by only 0.5 million barrels per day (b/d) in 2015, there would be little recovery from current prices levels or possibly significant further downward pressure on prices if OPEC producers do not take action to cut output. We are not ruling out a production cut from OPEC but wanted to examine what the oil price floor would be if the group did not act to support the market.

2. US tight oil breakeven prices are a good short term measure of how low prices can go as producers can adjust and shift their drilling programs relatively quickly. Using this metric, Brent prices are unlikely to be sustained below $80 per barrel in the shorter term – beyond 2015 – because of the effect on US tight oil growth.

3. The bulk of new US tight oil developments are economic down to $70 to $75 per barrel (WTI) or $80 to $85 for Brent. At $70 for WTI, (Brent near $80) the US tight oil sector loses about $15 billion in cash flow in 2015. This equates to a relatively minor 150,000 b/d in lost production growth in 2015, if fully cut from drilling budgets. If however, prices fall below this threshold and remain there for much of 2015, around 0.6 million b/d of US tight oil supply growth would be under serious threat by the end of next year, a volume that would increase each year with low prices.

4. The loss of these growing volumes would help move the market back into balance and stabilize oil prices. In addition, another impact on supply from low prices would be underway. Projected growth or development of future oil supply will also become curtailed by low oil prices. Development of high cost future supply or what is called marginal oil supply is at risk in a low oil price environment but the impact of this occurs over a 3-5 year time frame. The US tight oil market is the most flexible because of the scope for relatively rapid changes in production levels.
Source: Wood Mackenzie