Ex­pert sees macroe­co­nomic risks for oil in­dus­try

Kuwait Times - - BUSINESS -

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.

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