Oil price stumbles
Dips, rises on speculation about OPEC, Russia agreeing to more production
Volatility has returned to the global oil price, as a report on May 24 suggested that a meeting between Russia’s energy minister and a senior official from the Saudi Arabian administration was leading to an agreement to boost OPEC and Russian oil production in response to the climbing oil price. The price of Brent crude, which had been heading for $80 per barrel, promptly dropped back to below $75 in the succeeding days. But, following a media report on May 30 that the Organization of the Oil Producing Countries intends to stick with its production quotas, the price kicked back up to above $77.
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Given the linkage between the oil market and the complexities of the world economy and world geopolitics, attempting to predict the future price of oil tends to become an exercise in futility: There are multiple variables, some unpredictable, that interact to drive the market.
But the oil price does tend to be driven by supply and demand. So, it can be instructive to examine the various dynamics in the market, to assess where the market could go and what the future oil prices scenarios could be.
Robust demandOn the demand side, most commentators seem to agree that demand for oil products is relatively robust and is likely to increase, especially given the ever-rising standards of living in the developing world, particularly in China and India. Thus, despite rising worldwide oil production, oil demand has at least kept the market in balance. In fact, the latest data reported by the International Energy Authority indicates that demand is a little higher than supply, a factor that is pushing down oil inventories and creating upward pressure on the oil price.
An Energy Information Administration analysis of commercial inventories of liquid fuels in the countries of the Organization for Economic Cooperation and Development shows that the inventories, having climbed above their five-year average in 2015, have now dropped back to that five-year average. S&P Global Platts has reported that a senior OPEC source has said that OECD stocks have now, in fact, fallen below their five-year average.
There are uncertainties around future oil demand, particularly in relation to future energy technologies. There appears to be a general view, for example, that the use of electrically powered cars will increase substantially. However, there is also a view that the impact of economic growth on energy demand will exceed the impact of electrification on liquid fuel use and petrochemical demand. And then there are issues relating to climate change and the impact of changing energy policies on the required mix of energy sources.
Several supply factorsOn the supply side of the market, there are several key factors at play. The OPEC and Russian production quotas, started in January 2017 in response to the 2014 crash in the oil price, have been the key factor in pushing the price back up. An underinvestment in conventional oil development in some parts of the world because of the low oil prices may now be dampening production from conventional oil fields. Unstable geopolitics in the Middle East have created supply risks and associated oil price hikes. And then there is the issue of U.S. shale oil production, with its potential to become a price setter in the oil market.
On May 30, in a speech in Azerbaijan, Mohammed Barkindo, OPEC secretary general, lauded the OPEC oil production quotas, saying that the quotas had “halted the worst oil market downturn in history” and had achieved a positive impact on the world economy. Barkindo made no statement regarding the future of the quotas but remarked that “every effort should be made to avoid a potential supply gap” in the face of rapidly increasing global oil demand.
Barkindo also commented that the pace of investment in oil development has gradually picked up but that there is still not enough investment in the long-cycle projects that would underpin future oil supplies.
The continuing collapse of Venezuelan oil production is also impacting overall OPEC oil output.
In terms of the Middle East political situation, the decision by President Trump to reinstate sanctions against Iran created jitters in the oil market, pushing up the oil price.
US shale oilThere has been a debate regarding the potential role of U.S. shale oil in setting global oil prices. The nature of shale oil development enables production to be ramped up and down in response to price signals. And rapid technology advances, in combination with the perfection of development and production techniques, have caused a steady drop in the breakeven price level at which shale oil becomes profitable. A March report by Wood Mackenzie indicated an average breakeven Brent crude price of $55 per barrel for U.S. shale oil, a drop from a $75 breakeven price determined three years earlier.
But development also requires a willingness for investors to put capital into shale oil. And some people have expressed skepticism over the true elasticity of shale oil development - there may be limitations in production increases as the “sweet spots” for development become worked out, and as the density of drilling increases.
However, an examination of U.S. shale oil production rates over the years seems to argue for a continuing ability to respond to the oil price. Production rose rapidly in the heady days of $100 plus oil, before falling rapidly when the oil price crashed. The subsequent oil price rise triggered a steady increase in shale oil production, an increase that continues unabated at present.
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