IEEJ：October 2014

ｃ○ IEEJ 2014

Special Bulletin

A Japanese Perspective on the International Energy Landscape (191)

October 17, 2014

Crude Oil Prices Plunge Rapidly with WTI Slipping below $80
Ken Koyama, PhD
Chief Economist, Managing Director
The Institute of Energy Economics, Japan

Crude oil prices are falling rapidly. On October 16, the West Texas Intermediate crude oilfutures price (for the front-month contract) slipped below $80/barrel for the first time in about 28
months, since late June 2012, briefly hitting a low of $79.78/barrel. Although the day's closing pricegained $0.82/barrel from the previous day to $82.70/barrel, the decline in crude oil prices has
accelerated since early October. What we see now could be described as a plunge. The futures pricefor another international benchmark crude oil, Brent, has also fallen sharply. On October 16, theBrent price dived to a four-year low below $83/barrel, before closing slightly higher at $84.47/barrel.
As noted in “A Japanese Perspective on the International Energy Landscape (189),” crude
oil prices entered a downward trend in September. After dropping below $100/barrel in September,
the WTI price slipped below $90/barrel on October 3 in a continuous decline. This time, the WTIfutures declined below $80/barrel, though temporarily. Market players are paying attention to how
far the WTI and Brent prices would drop toward the $70/barrel level.

Multiple factors have been combined to cause the downward trend for crude oil prices (asnoted in the earlier report). Key factors among them are fading concerns on oil supply interruptions
resulting from geopolitical risks like the unstable Iraqi situation, a global oil demand slowdown anddownward revisions to oil demand forecasts amid global economic slump fears, the continued
expansion of global oil supply through the sustained rise in U.S. shale oil production and a Libyan
oil production recovery, the resulting easier supply-demand balance in the international oil market,
and the rising dollar's downward pressure on crude oil prices. However, new factors emerged thisweek to exert strong downward pressure on crude oil prices.

The new factors are global economic turmoil and a growing sense of insecurity about thefuture, as symbolized by the recent global stock market decline. The Dow Jones industrial averageon the New York Stock Exchange plunged from the year's closing high of 17,279 on September 19 to16,074 on October 16. The stock market decline has not been limited to the United States. Japan'sNikkei stock average on October 16 posted a 10% plunge from this year's high. The German stockmarket logged a 14% dive, symbolizing the recent European economic slump. As China, India and1

IEEJ：October 2014ｃ○ IEEJ 2014

other emerging economies have slowed down with downside risks seen after driving the world
economy and there has been a growing sense of insecurity about the future European economy, theUnited States has been expected to drive the world economy. Under such situation, markets havetended to overly react to any economic indicators that add to insecurity about the future U.S.
economy. Some analysts have noted that Ebola epidemic fears, though having little connection withmarket fundamentals, have contributed to market turmoil.

Also behind the oil and stock market plunge has been the U.S. Federal Reserve's decision
to end its third quantitative easing after confirming an economic recovery. As massive liquidity
provided throughout the world through quantitative easing is being rolled back due to the decision,
the emergence and growth of various economic risks are apparently leading funds to shift fromhigh-risk assets to lower-risk assets. In this sense, funds might have been shifting from crude oil andother commodity markets as well as stock markets to U.S. Treasury and gold markets, trigging thesharp falls in stock and crude oil prices.

Given the above, how far crude oil prices will decline depends first on when the global
economic insecurity or turmoil will end. At present, I have no choice but to say that the future is too
uncertain. Some analysts say the U.S. economy as a driver of the global economy is firm and will
steadily recover or expand, leading to a market rebound. But we cannot brush off downside risks for
the United States and the world economy. In this sense, I expect that crude oil prices will fluctuate as
the world economy seesaws through late this year or early next year. If the market weakens, crude
oil prices may slip below $75/barrel (or $70/barrel depending on some developments).

Second, how far crude oil prices will fall depends on what Saudi Arabia will do. Saudi
Arabia has so far seemed to have maintained its basic stance of leaving the market to determine
crude oil prices without resorting to any substantial production cut. At a time when crude oil prices
have actually fallen below $90/barrel and are likely to further decline, however, Saudi Arabia may berequired to consider what to do next. Present crude oil prices are below the level (about $90/barrel)
required to balance its budget. In this sense, Saudi Arabia has a motive to reverse the price trend. At
the same time, however, Saudi Arabia has had a budget buffer accumulated through massive oilrevenues in the past, remaining able to tolerate low crude oil prices over a certain period of time.
Saudi Arabia may have to strategically consider (1) what implications the low crude oil prices would
have for the world economy, (2) how the low crude oil prices would affect the international oilmarket for Saudi Arabia and its potential rivals (including U.S. shale oil production, Iran, Iraq andRussia) from the geopolitical viewpoint, and (3) how the low crude oil prices would affect Saudi
Arabia's relations with the United States that holds the key to security for the oil kingdom.

As many factors of the future are thus uncertain, the international oil market is expected toremain unstable while testing lower ground than the present levels in the immediate future. We will
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thus have to closely watch world economy fundamentals, international financial market trends,
geopolitical risks and Saudi policy developments.

Contact: report@tky.ieej.or.jp
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