You Can’t Always Get What You Want (The Future of Oil Prices)

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Oil well

 

“On energy, we will cancel the restrictions on the production of American energy, including shale, oil, natural gas and clean beautiful coal.”

 

Drilling restrictions in the US will be lifted to allow more oil production. At the same time, oil prices declined by 6% last week and hit a low since November, when the new administration announced its intent to unleash the oil production capacity of the US to create more wealth and jobs. The price of the WTI is at 45.9 $/ barrel, lower than when the Opec announced its decision to curtail output.

What is the future of oil prices?

Goldman Sachs had projected a price of 50$/ barrel for 2017 and 55$ in 5 years, however it recently announced that this target is unlikely to be met and that the market is about to “capitulate”. It is unclear what this means but it is more likely than not that oil prices will fluctuate in a 10-20% range in the medium term. http://www.cnbc.com/2017/04/12/goldman-sachs-anticipates-return-to-long-term-oil-price-stability.html.

This is bad news for large oil producers such as Russia and Saudi Arabia that still need a price of 66- 68 $/ barrel to balance their budgets after large cuts in public expenditure.

The new economics of oil

Oil is the most traded energy source and its price depends much more on the global market than on policy statements. Markets are about demand and supply. Demand is growing slowly. The IEA has revised its 2017 forecast for the increase in demand from 1.4 to 1.3 mbd https://www.iea.org/oilmarketreport/omrpublic/

Supply is abundant, its profile having radically changed since the shale oil revolution in the US. Before that, Saudi Arabia was the swing producer given its capacity to increase/ reduce production to stabilize prices.This has been turned upside down with shale oil production in the US, which created a “new economics of oil”. http://www.cnbc.com/2017/04/12/goldman-sachs-anticipates-return-to-long-term-oil-price-stability.html.

At a certain price, US shale oil producers can increase their production almost overnight and this offsets cuts in Opec production. What is the price?The figure from BP shows the long term marginal cost of shale oil at 50- 60 $/ barrels (although its cash cost is substantially lower). Rystadt Energy has a lower estimate, 36$ dollars on average, only.

US shale producers keep on surprising by their capacity to discover new resources, reduce production costs and sustain lower margins. A recent paper by the Federal Reserve Board (Unraveling the Oil Conundrum: Productivity Improvements and Cost Declines in the U.S. Shale Oil Industry) shows the sources of productivity gains. https://www.federalreserve.gov/econresdata/notes/feds-notes/2016/unraveling-the-oil-conundrum-productivity-improvements-and-cost-declines-in-the-us-shale-oil-industry-20160322.html

Winners and losers

The relationship between oil prices and economic growth is much more complicated than in the past as shown in a recent post of Maurice Obstfeld, the Chief economist of the IMF.  https://blogs.imf.org/2016/03/24/oil-prices-and-the-global-economy-its-complicated/ However, oil importers are winners and oil exporters are losers. Europe and China are oil importers and they should be grateful to the decision to unleash US oil production

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