One-two punch knocks oil prices down

Friday, March 20, 2015

By Farrokh Langdana, Director, Executive MBA Program & Professor of Finance and Economics

Faculty Blog: business.rutgers.edu/langdanamacro

Oil prices are falling due to two factors. A drop in global economic activity (China, India, Europe) has pushed demand down. And OPEC countries have increased the supply of oil to maintain revenue to match their spending.  They essentially have to produce more lower-priced barrels to meet their revenue needs. So this one-two punch—the drop in demand and the increase in supply—has pushed oil prices down.

Source: Doug Hatler, Rutgers EMBA alum

If sanctions are lifted on Iran—if there is some sort of a "nuclear" deal—then the expected increase in global oil supply will drop oil prices even further. If this is the case, then the shale sector, and the investments therein will come under significant pressure. Bond investors who have helped fund America's shale boom will be under stress.

Since 2000, the shale sector (energy companies) have issued more than $150 billion in high-yield bonds which now account for 15% of the $1.35-trillion U.S. junk bond market. As oil prices continue to drop, these bonds may be the next US bubble.

In addition, geopolitically, the increase in oil production has significantly reduced Russian President Vladimir Putin’s ability to finance more global (mis)adventures like interference in Ukraine, making pundits re-examine the power of commodity prices in global geopolitics.

The trends that pushed oil to these historic lows are likely to continue with demand sluggish and Opec intent on maintaining its market share. 

TAGS: Business Insights Farrokh Langdana Finance Oil Markets