The steep decline in oil prices could be a result of the rise in oil firms' debt levels and expectations about future market conditions, says Bank of International Settlements, BIS.
The sudden decline in oil prices and daily fluctuations remain a financial asset, BIS added on its preliminary study of oil-debt nexus before its Quarterly Review in March.
'As with other financial assets, movements in the price of oil are driven by changes in expectations about future market conditions,' said the international organization of central banks based in Basel, Switzerland.
The rise in oil companies' debt levels, the overall decline in investments for new exploration and production capacities and difficulties with firms' cash flows all have negative effects on the expectations in the market, which can lead to a price fall.
Oil prices have fallen around 60 percent in the last seven months, reaching their lowest level in almost six years, and recording the fastest dive since 2008, due to oversupply and low global oil demand.
The organization pointed out that oversupply was also evident in 1996, when low demand and fall in consumption was seen then and also in 2008.
However, those reasons in the past are in contrast with the current price fall since June 2014, the organization maintains.
The Asian financial crisis in 1996 threatened most of East Asia and rest of the world, as global demand for oil fell, and prices dived from $25 to $11 per barrel between 1997 and 1999.
Likewise, the global financial crisis in 2008 led to the fastest slump in history, as oil prices plummeted to $36 per barrel in Dec. 2008, falling almost 80 percent, due to low demand.
'The greater willingness of investors to lend against oil reserves and revenue has enabled oil firms to borrow large amounts in a period when debt levels have increased more broadly,' said BIS.
'The greater debt burden of the oil sector may have influenced the recent dynamics of the oil market by exposing producers to solvency and liquidity risks,' it added.
According to BIS, decline in oil prices weakens the producers' balance sheets and tightens their credit conditions, while it reduces cash flows and raises the risk of liquidity shortfalls.
Another factor that extended the price decline is that many oil companies in emerging economies borrowed in U.S. dollars which increased the amount of debt, said BIS.
The organization underlined that the relationship between oil prices, debt and the balance sheet is new in the oil markets, adding 'the build-up of debt in the oil sector is a reminder that high debt levels can induce significant macro-financial interactions.'
BIS stressed that the recent OPEC decision not to cut production has been key to the fall in the oil price, while other factors may have worsened the oil price slump.
OPEC, the Organization of the Petroleum Exporting Countries, met on Nov. 27 to devise a strategy against falling oil prices but decided not to cut production to prevent the sharp decline.
The global consulting company Wood Mackenzie also warned on Jan. 23 that 46 international oil companies' total net debt summed $53 billion since 2010, advising the oil and gas industry to cut costs by $170 billion, or 37 percent, for the companies to maintain their debt at 2014 levels.
By Ovunc Kutlu
Anadolu Agency
ovunc.kutlu@aa.com.tr