Expert sees macroeconomic risks for oil industry
LONDON: The global oil industry now appears to be in the early stages of a cyclical expansion which is likely to see prices rise over the next few years, slowly at first but then accelerating later.
Deep and long cycles in oil prices have been the defining characteristic of the industry since the 1860s. The boombust cycle which started in late 1998, with prices briefly below $10 per barrel, and was only briefly interrupted by the recession of 2008/09, ended in January 2016, with prices briefly below $28.
In the 18 months since then, the industry has returned to an expansion phase, with a gradual increase in prices and drilling activity, much of it centered on the shale plays of North America. Most of the industry’s cyclical indicators (production, consumption, stocks, investment, employment, prices, costs) point to a sustained upswing in activity that is likely to continue in the short and medium term.
Forecasting future movements in oil prices will always be subject to an enormous amount of uncertainty owing to the complex and non-linear dynamics of the oil market and all its sub-systems. “We’ve never been any good at predicting these cycles, neither when they occur nor their duration. We don’t spend a lot of time even trying,” Rex Tillerson observed in 2016, when he was still chief executive of Exxon.
“How the future is going to look, we take no particular view on it, other than to recognize that whatever it is today it will be different sometime in the future, and after that it will be different again.”
Price predictions have proved a regular graveyard for the reputations of even the most skilled oil analysts. But with the oil industry just emerging from the deepest slump in a generation, cyclical positioning strongly suggests that prices are more likely to move higher rather than lower in the next few years.
The industry’s costs, which have always been pro-cyclical, are also likely to rise as the slack carried over from the downturn is absorbed and the supply chain tightens. The main uncertainty centeres on how far and how fast oil prices and the industry’s costs will rise in the years ahead.
Experience suggests the expansion is often slow and faltering at first and then accelerates as inherited slack is used up, memories of the downturn fade and confidence improves.
Too fast, too soon
The principal risk in the short term is that prices and drilling rise too far too quickly, overwhelming growth in consumption, and sending the industry back into a slump. Something like this occurred in the first half of 2017, with private equity investors, shale producers and hedge funds all trying to anticipate a cyclical recovery and pushing drilling rates and oil prices too high.
The result has been an inevitable setback, with oil prices falling from their peak in February, rig counts apparently reaching a temporary plateau, and more cautious positioning from hedge fund managers. The longterm cyclical recovery is likely to see more of these mini-cycles, as oil prices, capital investment, hedge fund positions and drilling expand unsustainably and then fall back. The basic trajectory, however, should remain one of a long cyclical upswing over the next few years.
The principal medium-term risk comes from the global economy, with the increasing probability of a recession in the advanced economies sometime before the end of the decade. The current economic backdrop is exceptionally favorable for the oil industry, with a sustained expansion in business activity and a gradual acceleration in trade flows in most regions of the world. But the major economies, like the oil industry, are subject to long and deep cycles in activity, which have an impact on oil demand and prices. Unlike the oil industry cycle, which is in the early stages of expansion, the macroeconomic cycle in many of the advanced economies looks increasingly mature.
The US economy has expanded for 98 months, since hitting a trough in June 2009, according to the National Bureau of Economic Research’s Business Cycle Dating Committee. The cyclical business expansion is already the third longest on record and will become the longest if the economy is still expanding in July 2019, surpassing the long boom of the 1990s.
There is a lively debate among economists about whether business cycles die of natural causes (because of accumulating imbalances in investment, inventories and financial markets) or are murdered by policymakers to control inflation or as a result of policymaking errors.