Oil price fall exacerbated by hedging, energy firms' debt

LONDON: Oil's dramatic price fall since mid-2014 cannot be explained by changes in production and consumption alone, with hedging and energy firms' high debt levels also playing a part, the Bank for International Settlements (BIS) said.

The BIS compared oil's recent fall, which saw prices collapse to below $50 a barrel from levels of above $100, with declines in 1996 and 2006 and concluded that unlike on previous occasions, this time oil production has been close to expectations and consumption was only slightly below forecasts.

"The steepness of the price decline and very large day-to-day price changes are reminiscent of a financial asset," said the organisation, representing central banks around the world, on Saturday.

While the recent OPEC decision not to cut production "has been key to the fall", other factors could have exacerbated it, the BIS said. These included increased indebtedness in the oil sector in recent years.

The Basel-based organisation said this greater debt burden may have had an influence on the oil market itself.

"Against this background of high debt, a fall in the price of oil weakens the balance sheets of producers and tightens credit conditions, potentially exacerbating the price drop as a result of sales of oil assets," it said.

The BIS said reduced cash flows as a result of a lower oil price heightened the risk of firms being unable to meet interest payments and this could lead them to continue pumping oil to maintain cash flows, delaying a reduction in supply.

This may be a particular factor in emerging markets where a stronger dollar would hit indebted companies even harder.

An increased reliance by oil producers on swap dealers as counterparties for their hedging since 2010 may also have played a part. Dealers may "at times of heightened volatility and balance sheet strain for leveraged entities... become less willing to sell protection to oil producers," the BIS said.

It said volatility in the oil price "suggests that dealers may have behaved pro cyclically - cutting back positions whenever financial conditions become more turbulent".

This in turn may have led producers wishing to hedge falling revenues to turn to derivatives markets directly and could have played a role in recent price moves, the BIS said. - Reuters