Why Global Oil Companies Won’t Cut Production

Friday, October 16, 2015

A market component driving down oil prices may surprise many privy to the market. An inordinate number of oil producing countries aren’t responding to the market climate and continuing production as normal. This despite the plummeting price of the resource thanks to a supply outstripping demand throughout 2015.

Typically as demand for a commodity falls, producers will cut supply output to prevent market saturation. The concept is this will drive up the price of the commodity because it’s more valuable with less of it available. This is business 101. But if there is no market correction in the event of a price drop, and production continues as normal, the market will never correct.

With prices having dropped 50% since June of 2014, oil supply from many countries has grinded to a crawl. US oil companies have been forced to decommission about 40% of the rigs fully functioning no more than two years ago. In the face of plummeting oil prices, however, Saudi Arabia actually ramped up oil production by roughly 1 million barrels daily. With this, the country is inarguably losing billions annually but is intent on increasing market share for “when oil prices rebound.”

And the Middle East oil giant isn’t the only country ignoring procedure. The theory driving Russia’s decision to not cut oil production, according to its Deputy Prime Minister, is “If oil prices stay low longer enough, supply will go down naturally.” Russia intends to continue to flood the global oil market with their vast supplies, effectively dragging down prices worldwide.

Effectively, OPEC- the cartel for nearly 30% of the world’s oil-- is forced to continue cutting prices. Opec, however, is not without blame for the current state of the oil market. Having let prices stay as high as they did for so long, the coalition essentially ushered in the current market conditions. This allowed new competition from US oil and newly-tapped fracking reserves.