The Oil Price Resurrection

The market has a long way to go, before delivering long-run balance.

The oil industry has witnessed a drastic downturn over the last two years. Historically, an oil bust is usually followed by a recovery or a boom. But, a recovery has been tentative this time round. Late last year, the OPEC reached an agreement to cut down oil production; an agreement that has surprisingly survived. Despite oil prices strengthening in the past few months, he United States’ inventories recorded a projection of weaker prices. In June 2014, the oil price per barrel of Brent crude was $110, dropping to only $60 early 2015. Today, the barrel goes at $33 – a breath-taking decline since 2004. And, since mid-2014, oil production has been in excess of demand, pushing down the price.

While the period of 2010-2014 saw recovery from the financial crisis in most of the oil-producing economies, global production was still imbalances. This had forced countries to reduce their stockpiles, and oil prices soared again. The result of this was that most of the oil fields were stagnant and oil production was restricted by conflicts in the OPEC members like Iraq and Libya. Some economies like the US doubled their crude oil production since 2010. The crash cropped in when supply eventually met demand, and then surpassed it.

Mid-2014 witnessed low demand following higher production by Iraq and Libya, China’s economy stumbling, and Europe reeling from the Eurozone mess – prices dropping to $70 per barrel of Brent crude. In addition, Saudi Arabia unexpectedly increased its oil production to maintain its competitiveness, hoping to crush US frackers, should prices fall. Since Saudi Arabia’s decision, oil prices have been plummeting – $50 per barrel, then $40, then $33 – since supply is more than demand.

What followed was a slew of logical reactions from the oil producing economies. By 2015, US oil production adapted to low oil prices than Saudi Arabia’s expectations, as companies reduce costs and increase productivity of oil flow. Iraq doubled oil production since 2014 following a recovery from conflict.

Major global economies including Russia, China, and Brazil were entrapped in a decline, dampening oil production. Automobile owners were spending way less on gasoline, saving more for other expenditures. Oil producers such as Russia, Saudi Arabia, and Venezuela were forced to balance their budgets back in 2015, suffering from revenue crunch. Oil companies particularly in the U.S were losing profits. Banks that financed the US shale boom were suffering from defaults and developing economies financially dependent on petrodollar were hurt.

The oil industry stakeholders are enlightened by the Trump administration. The new presidency supports the industry’s proposals to build additional pipelines (e.g. Keystone XL) to deliver Canadian oil to refineries in the Gulf of Mexico and open more deep waters and federal land prospects for oil drilling. The administration will also lessen the regulatory burdens on the industry to boost productivity. Enacting these proposals would increase the supply of natural gas and oil on the international market – possibly lowering the prices. In contrast, reinstituting sanctions lifted in multilateral nuclear deal with Tehran would constrict oil export from Iran. This would lower supply and thence increase oil prices.

2017 will see a further decrease in oil prices. A demand recovery cannot be expected for fuel-based automobiles in the retail sector in some parts of the world, because of the gaining momentum of non-fuel-based vehicles like electric cars. But this is the scenario for the long-term. There is a chance of recovery in economies like the US, where summers mean road trips.  On the other hand, decreasing inventories and the existing weaker demand would make oil prices plummet further. The good news may be that, for now, the market will be balanced, as long as economies like Russia stay on their path of production cuts.

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