Higher oil demand is needed to end the glut, but will it come?
At various points over the past year, hopes have risen that production cuts by OPEC would succeed in draining the world’s oil inventories enough to bring prices into the $55-per-barrel range needed for U.S. producers to really get moving again.
Those hopes have been dashed consistently, with prices lingering below $50, and now economists at the Dallas Federal Reserve say that the supply glut is likely to continue far into next year. That’s bad news for Houston’s oil-bound economy, which may not see the strong recovery that some have anticipated.
The culprits in all this are U.S. shale drillers. Over the past year or so, they have more than doubled the rig count, bringing so much supply online that the market has yet to tighten enough to force prices up — even as the OPEC-led coalition of oil producers extends output cuts of 1.8 million barrels per day into next year. (Robust oil shipments from Libya and Nigeria aren’t helping, either.)
“There is substantial agreement that U.S. fracking activity has moved too far and too fast, growing U.S. production at an uneconomic pace,” Bill Gilmer, a regional economist at the University of Houston’s Bauer School of Business, said recently. “U.S. producers are again chasing equity gains at the expense of long-run profits, just as they did from 2012 to 2014.”
In case you need a reminder, 2014 was the beginning of the worst oil bust in a generation, as a glut of oil set off a two-year dive that sent oil prices tumbling from more than $100 a barrel to less than $30. So why are shale producers acting in this “uneconomic” way again?
Gilmer explained that a combination of easy credit, still-depressed oil servicing costs, and the ability to hedge prices in the futures market is driving oil companies to keep drilling. A few of those factors should fade, as low yields make drilling projects less attractive to investors and oil field services companies start to charge more (especially considering the mounting difficulty of finding workers).
What would really boost oil prices, however, is an increase in global demand, which is not coming on as strong as the oil industry might hope. The latest projection from the U.S. Energy Department forecasts energy consumption in India and China will rise, but only moderately.
In the U.S., meanwhile, President Donald Trump recently celebrated low oil prices as good for consumers.
“Gas prices are the lowest in the U.S. in over 10 years!” he tweeted last week. “I would like to see them go even lower.”
Despite those low prices, demand for gasoline from American motorists continues to slump, according to the Energy Department, in large part because of improved fuel efficiency. Long term, increases in electric, hybrid and self-driving vehicles are expected to dampen oil demand further.
So, barring big supply shocks or an unexpected economic boom, anybody who lives or dies by the price of oil might want to settle in for a long slog.
“There is substantial agreement that U.S. fracking activity has moved too far and too fast.” Bill Gilmer, the University of Houston’s Bauer School of Business