Why it won’t be long before crude oil prices rise again
CHINESE CONSUMPTION WILL GROW, SO LONG-TERM SIGNS SHOW DEMAND WILL KEEP RISING
The oil price collapsed last Monday after an acrimonious meeting of the Opec exporters’ group. Having been above $105 a barrel in June last year, US crude fell to $37.65 — a 64 per cent drop in just 18 months. After staying well above $40 a barrel for months, crude has now crashed decisively through. That psychological lower threshold having been breached, there is now widespread speculation that crude could tumble much further — maybe even to $20.
I don’t buy that. Just as fast as crudes prices have fallen over the past year or so, they could easily spring back again. One reason is that these recent drops reflect supply patterns that are driven almost entirely by geopolitics — and geopolitics can quickly shift.
It’s also axiomatically true that a collapse of the crude price, from an average of $94 a barrel in 2014 to $49 so far this year, entirely contradicts the long-term fundamentals of ever-rising global oil demand and the geological and logistic constraints on future increases in supply.
Last November, Saudi Arabia decided that Opec would not cut its export quota in the face of falling prices. The idea was to keep pumping to drive prices even lower, knocking upstart and relatively high-cost US shale producers out of the market.
Opec’s strategy has worked in the sense that we now have a short-term supply glut which, together with a slowing Chinese economy and expectations that Iranian oil could soon hit global markets, has resulted in big price falls. It’s also caused a slowdown in the rate of growth of American crude production, which rose 16 per cent to 8.7 million barrels a day in 2014, but is this year on course to grow just 7 per cent to 9.3 million barrels daily, as many shale producers have indeed suffered from low prices and been forced to close.
Far from retreating, though, Riyadh is pursuing race-to-thebottom pricing even further.
No matter that war-torn Libya, battling Daesh and in the midst of its own civil conflict, is producing just 400,000 barrels a day, down from 1.5 million under Muammar Gaddafi, absorbing the twin revenue shock of both far lower output and a much reduced price. No matter that even Saudi Arabia itself is suffering — with cheap oil resulting in a 20 per cent of GDP budget deficit, and a large share of its fast-growing 30 million-strong population highly reliant on oilfunded government handouts.
Production cap
One problem Riyadh has is that the US shale industry has shown determination, with many small and medium-sized shale producers clinging on — and the Saudis don’t want to lose face. At the same time, if a new production cap is announced, the Saudis don’t trust other large Opec members not to break the cap, so muscling in on Saudi’s market share.
Then there’s Russia, outside Opec and constantly vying with the desert kingdom to be the world’s biggest oil producer. An Opec production cut could make yet more room for Russian crude. And Moscow is less bothered about cheap oil than Riyadh — given that, in rouble terms, prices have not fallen so far.
However, I still believe crude prices could bounce back soon. One reason is that the “Chinese demand is falling” argument has been overdone. Yes, China is now growing by 5-6 per cent a year, rather than the 9-10 per cent annual average it has chalked up since the early Nineties. But the Chinese economy is now far bigger than it was just a few years ago, so its oil use still rises substantially, from year to year, even if growth slows.
At the same time, the plucky US shale industry, having put on a brave face, is showing signs of genuine strain. Over the past year, the US “rig count” has dropped by 62 per cent.
Across the entire world, investment in oil exploration and production has nosedived from $700 billion in 2014 to $550 billion this year. With oil now below $40, investment projects will now be dropping like flies.
Meanwhile, Western equity markets continue to soar. Distress levels in junk bond markets hit their highest levels last month since September 2009, according to Standards & Poors. And that alarming statistic derived largely from highly-leveraged North American energy producers doing everything they can to survive in this environment of artificially cheap crude. So, low oil prices feel nice. But there will be relief in many quarters, not just among Opec members, when prices go back up.