Everything about the oil market – 2015 and 2016 edition – is peculiar. Oil prices have plummeted, yet production has not, defying textbook economics. In some big oil-producing regions, output is actually rising. Demand is up too, yet prices could keep falling. Still, oil could be the commodity bargain of the decade.
How to make sense of all of this? Not easily, because this particular price collapse is unlike the others, so history provides a lousy playbook.
American shale oil was not a factor in the last big collapses, for the very good reason that there was no way to get it out of the ground economically. Now, it's gushing forth in quantities that could fill small ocean basins. The Organization of Petroleum Exporting Countries (OPEC) was still the price setter – had been since the early 1960s – ensuring that most severe price downturns were fairly short-lived. Today, OPEC is pumping like mad, seemingly happy to cast off its previous status as a ghastly, though effective, price-supporting cartel. And there is no recession this time around, even if growth is weak in some parts of the world.
Commodity prices are notoriously hard to analyze and forecast because so many dizzying factors are involved – supply, demand, geopolitics (including embargoes and sanctions), technology (as with hydraulic fracturing, horizontal drilling and other clever extraction gizmos that only oily nerds understand), car fuel economy, carbon taxes, fuel subsidies and wars.
But the variable that seems to apply most to this particular price disintegration is supply, and lots of it. Supply has been outpacing demand, which is why any rally since the great price downturn that started in mid-2014 has been short-lived. The surge that began late last week and took oil prices to more than $34 (U.S.) a barrel from $28 seems unlikely to last. Prices are still down about 35 per cent in the past year and about 70 per cent in the past year and a half.
It is fashionable and facile to blame China and its waning annual growth rates – now down to less than 7 per cent, if you believe the figure, from 11 per cent or so for the past decade. Were it all so simple. China's economic growth rate may be down, but the country is still growing, from an ever-larger economic base, and oil consumption is hardly collapsing – the opposite in fact. The International Energy Agency (IEA) says China's oil consumption climbed about 600,000 barrels a day in 2015, or 6 per cent, which should not be surprising since popular products that come with deep-discount stickers tend to pick up sales. Global consumption rose almost 2 per cent.
So much for the theory that weak demand is to be blamed – or credited, depending on your point of view – for oil's capitulation. Far more sensible to blame rising supplies. Shale production in the United States is now falling as drilling rigs are sent into early retirement, but production still increased last year and the shale bonanza has boosted global supply by 4.2 million barrels a day over the past five years.
Output in the North Sea and Russia is up, and Canada's oil sands production is set to rise substantially by 2020. Sanctions-free Iran, which is sitting on the world's fourth-largest reserves, intends to throw another 500,000 b/d onto the export market. Saudi Arabia isn't scaling back, in the hope that opening the spigots will choke off non-OPEC production. The strategy hasn't worked so far, in good part because expensive projects, like the oil sands, cost more to shut down and restart than to keep running, even when oil prices are low.
As the supply glut builds, oil prices could fall even if global demand stays intact or rises. On Tuesday, the World Bank sliced its 2016 forecast for an average crude oil price of $37 a barrel from the previous forecast, made only three months ago, of $52. Even the new figure may be ambitious. In his popular Energy Matters blog, Scottish oil writer Euan Mearns observes that oil, adjusted for inflation, would have to slump to $20 to hit the low seen in 1998; he expects oil to fall. Given the supply overhang, the question should not be "Why has oil fallen so far?" but "Why has it not fallen further?"
For oil bulls, the good news is that, at some point, low oil prices will choke off production as projects are scaled back or abandoned. Already, almost $400-billion of projects have been suspended. The IEA says energy-project spending fell 20 per cent last year and is on course for a similar fall this year – an unprecedented back-to-back, double-digit investment plunge.
The best cure for low prices is low prices, as market economists say. The questions, though, are whether $30 oil is really low, given the supply glut and, when the inevitable rebound comes: will it be in 2017 or years later? What does seem likely is that oil below $30 is as unsustainable as $110 oil. Demand, after all, has not collapsed, no matter what nonsense you read about China sinking the oil industry.