Falling global oil prices could slow down investment in Kenya’s oil

Global oil prices are spinning out of control. Prices came under intense downward pressure as global output of crude oil outstripped demand, especially this year. The global benchmark, Brent crude oil fell below $70 per barrel, it’s lowest level since 2010.

What caused oil prices to rise to such unprecedented high levels?

You have to go back about nine years ago, to the mid 2000s when oil prices rose steeply owing to the unprecedented global demand caused by China’s meteoric rise. China with a GDP of $17.6 trillion is now the world’s largest economy, putting the United States in second place for the first time in 142 years.

The surge in China’s economic output and energy demand led to a large price spike, with Brent crude price holding steady at over $100 per barrel over the last four years. With what looked like a sustained surge in global crude prices, energy companies were persuaded going after tight oil would be immensely profitable.

Why are crude oil prices plummeting today?

The slowing down in global demand has triggered the inexorable decline in world crude market prices. This is due the slowing Asian economies and chronically slow and deteriorating European Union economies.

Asian economies are slowing down as fallout from “re-balancing” in China. China’s re-balancing will require lowering investment levels, increasing household consumption, which must grow faster than GDP, and reducing the role of the state sector. Several new reports indicate that the European economy is stagnating and is at risk of a deflationary spiral. The European Central Bank has downgraded growth in the euro zone to just 1 percent in 2014. The core of Europe, Germany and France, is in recession.

Another demand-supply influencing factor is the US domestic crude oil production. Domestic crude oil production levels have increased since prices spiked in 2008, exceeding net imports in 2011.

And what has been the global response, if any?

Organization of Petroleum Exporting Countries (OPEC) – a cartel of oil producers that includes Saudi Arabia, Iran, Iraq, and Venezuela – met in Vienna last week with the expectation that it would cut petroleum production to forestall the plunge in oil prices. It did not; a sign that OPEC influence in the global oil market is diminishing or we have entered an era or crude price wars.

Is OPEC instigating a price war with other oil producers, notably the United States, Russia and Brazil? Will OPEC allow global oil prices to continue falling in the hope that many of the newest exploration and drilling operations will prove unprofitable and shut down?

US companies are using horizontal drilling hydraulic fracturing to extract oil from shale formation, techniques that are more expensive than pumping oil from conventional reservoirs. Is that why Abdalla El-Badri, OPEC secretary general, says the best cause of action is to do nothing; just wait and see how the market behaves, hoping that lower prices will discourage domestic production in places like the United States?

But more importantly, how does the plunge in crude oil price affect us here in Kenya?

 Falling petroleum prices will benefit Kenyan consumers and the overall economy. The cost electricity and transportation will drop markedly, causing higher consumption of oil products. Moreover, manufactures will reward consumers with lower prices, lowering inflation and spurring spending. However, in the short term, a glut in crude oil will slow down investments in renewable, clean energy such as wind and geothermal. Increased energy consumption is bad for our climate. It means higher greenhouse gas emissions.

Substantial and pro-longed decline in crude oil prices pauses huge risks for Tullow Oil. Plummeting oil prices could reduce its operating cash flow, reduce the value of its assets and cause development plans to stall. Falling oil prices could compound other risks Tullow already faces, such as long spells of unsuccessful exploration wells, political uncertainty and shifting fiscal and regulatory terrain in all three of the African countries it operates in.

What if OPEC is determined to decimate new investments in places like the US, Canada and Africa by allowing crude prices to fall below $75 per barrel? With crude oil prices in near free fall, can an exploration-focused company like Tullow survive? Will shareholders run for the hills?

But analysts estimate that South Lokichar Basin contains valuable light oil assets that would break-even below $50 per barrel. Keep your eye on crude oil futures.