Editorial: Oil dips below US$50 per barrel

Further sharp declines in oil prices to start 2015 are signalling that oil prices will be a major theme this year for miners.

The last time we editorialized about plummeting oil prices in mid-October, we were shocked that the international benchmark Brent crude had tumbled to US$84 per barrel and West Texas Intermediate was trading at US$82 per barrel — two-year lows representing declines of 25% since June 2014.

But as we go to press in early January, Brent has dipped below US$50 per barrel for the first time since May 2009 to US$49.92, while WTI is just US$47.65 a barrel, breaking through US$49 on Jan. 6 for the first time since April 2009.

Both Brent and WTI prices are now down about US$10 in the last two weeks and off an astounding 50% over the last six months.

The standoff between the world’s biggest oil and gas producers that sparked the price war in the first place is raging as fierce as ever, with the booming North American shale-oil sector ramping up production even as the oil-exporting countries of OPEC, led by Saudi Arabia, refuse to curtail production in the face of declining prices.

Many oil analysts are now predicting oil prices will move towards US$40 per barrel in the coming weeks, and that oil prices in the US$80 to US$90 range may not be seen again for at least a year or two.

Gulf state governments are assuming prices of US$60 per barrel in 2015 for budgeting purposes. Deutsche Bank and the International Monetary Fund note that the major oil exporting nations Libya, Iran, Algeria, Nigeria, Venezuela, Russia, Saudi Arabia and Iraq (in decreasing order of dependency) all need oil prices above US$100 per barrel in order to balance their budgets.

In an example of the weird distortions in the market that oil’s sudden price decline has created, look no further than Argentina, where Canadian junior Madalena Energy has 90% of its oil production. Madalena notes that in Argentina oil prices are set by the government for product sold into the domestic oil market, which is where Madalena sells its oil. For many years Argentina’s domestic oil prices were set well below the Brent price, but since May 2014, oil prices in Argentina have been set by regulators above Brent at US$83 per barrel, with January 2015 oil pricing set at US$77 per barrel for Medanito crude quality oil, allowing Madalena to enjoy selling oil this month for 54% higher than the current Brent price. (Foreign miners who have been burned in recent years by the national or provincial governments in Argentina surely have a few ideas on how this unusual situation may play out for Madalena.)

One feature of oil price reporting in the broad media is that it’s often portrayed as bad news when it’s going up sharply, and a whole different kind of bad news when it’s declining sharply.

But for miners and related companies who are only direct or indirect consumers of oil, this oil price decline is a boon to operations that has only been getting better with each passing month.

Caterpillar CEO Doug Oberhelman recently told CNBC that “the mining business is definitely bouncing off the bottom” and that lower oil and gas prices may help in providing a “‘stimulus program’ that we’ve all been blessed with [that] will work its way through eventually.”

We’ll look to the upcoming quarterly mine production results to see how much falling oil prices have helped cut cash costs beyond management’s earlier expectations, improving bottom lines in the fourth quarter of 2014 and the coming quarters in 2015.

Stressed mine management teams traumatized by years of falling mineral prices and rising costs will finally get a bit of a breather as cost control — which was emphasized in 2013–14 — exceeds expectations.

This will be doubly true in countries such as Canada and Australia, which have seen falling currency valuations that translate to lower labour costs for global miners reporting in U.S. dollars.