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Why Are Oil Prices Heading Down?

Singapore might not be an oil producer, but developments in the oil & gas industry are also important for our economy and share market. For instance, SembCorp Marine Ltd (SGX: S51) and Keppel Corporation Limited (SGX: BN4) – both mainstays in Singapore’s market benchmark the Straits Times Index (SGX: ^STI) – are both affected by the ebb and flow of the oil & gas industry.

Given the sharp fall in Brent crude oil prices recently (the commodity’s price has fallen by 20% from US$115 a barrel in June to US$90 on 11 October 2014), let’s take a look at what’s causing this drop and what’s in store for investors when it comes to the oil & gas plays in Singapore.

Several factors at play here

The price drop comes amid general concerns over weakening global demand in addition to a  supply glut from the U.S. due to increasing shale oil production. To make things worse, Saudi Arabia, the biggest member of the Organization of Petroleum Exporting Countries (OPEC), has been cutting prices unilaterally in order to compete with the U.S.

The U.S. produced 8.7 million barrels per day in September, the highest production figure since July 1986. This comes as a result of steep growth in shale production in the country made possible by new technologies used for extracting oil and gas from shale reservoirs, such as horizontal drilling and hydraulic fracturing. As more oil is pumped into the markets, it inevitably puts pressure on the price of crude oil.

As mentioned earlier, Saudi Arabia is prepared to let prices fall by paring output to clear a supply surplus, rather than cede market share. This might evolve into a price war between the OPEC nations themselves, as the other 11 members of the group might also want to defend their market share amid rising supplies and lukewarm demand.

The slowdown in China’s economic growth and the risks of Germany falling into recession (which might cause the whole of Europe to be in a recession) have also likely weighed on oil prices recently.  To exacerbate the issue, there’s a forecast for a warmer winter in the U.S., which points to lower consumption of energy.

Are things turning around?

In its report released on 7 October 2014, the U.S. Energy Information Administration (EIA) cut its crude oil price forecasts for 2014 and 2015 because of rising output and reduced demand. Even a fearful geopolitical backdrop – fighting in Iraq and Libya; tensions in Russia and Ukraine etc. – have not been able to contain the drop in oil prices.

With expectations of oil prices to remain low, it will also mean a gloomy outlook for energy-related companies. For instance, huge oil & gas companies like Chevron and Exxon Mobile have declined by 12.8% and 9.6%, respectively, since the start of July. On the local front, the two oil & gas-related companies – Sembcorp Marine and Keppel Corp -have slid by 9.8% and 6.4% respectively in the same period.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor James Yeo doesn’t own shares in any companies mentioned.