Oil prices fell on Thursday (3 May) due to a rise in US crude inventories and production, as was reported by Reuters. Brent crude oil futures, the main benchmark, were at $73.04 per barrel, down 0.4%, from their last close. Although the prices then recovered and reached $76 a barrel on Monday 7th May over possible Iran sanctions, this is not their first fall this year.
The US is producing more and more oil while OPEC and Russia are extending the curb in production until the end of this year. Bloomberg reported in March that oil prices could fall back under $60 a barrel because of rising U.S. exports. Could this be the beginning of a bear market for oil?
US Shale Dominance
The International Energy Agency (IEA) warned in February 2018 that
“the rise in global oil production, led by the United States, is likely to outpace growth in demand this year.’’
In other words, the world could be once again producing more oil than it needs. Oil prices fell about 1% in March this year, when US crude inventories rose to 1.6m barrels. With lower drilling costs and high prices, US companies are motivated to produce more. The country’s oil production hit 10 million barrels per day in late 2017, for the first time since the 70s, and has risen by nearly 25% in the last two years, according to U.S. Energy Information Administration.
“In just three months to November, (U.S.) crude output increased by a colossal 846,000 bpd and will soon overtake that of Saudi Arabia. By the end of this year, it might also overtake Russia to become the global leader’’
International Energy Agency, February 2018
The danger is that excess supply of a good eventually leads to a price drop because the market becomes flooded. Oil prices reached more than $100 a barrel in 2014, before crashing to a 13-year low of $27.10 in 2016, when there was an oil glut in the market due to the US shale revolution.
By economic laws, a high price attracts new producers because it becomes more profitable for them to produce more. When the supply exceeds the demand, the price drops, because the glut needs to be cleared. Will the history repeat itself and will the US oil production lead to a new oversupply?
What Keeps Oil Prices High
So far, the rising US supply has not dragged the prices down. This is because all the additional output has been absorbed by strong global demand. But also, because there are many other factors affecting the price of oil. Geopolitical risks (for example, current political instability in Venezuela and the danger of sanctions against Iran) mean that the supply could be suddenly cut short and this supports the price.
Source: Reuters
The amount of oil in the market is being restricted by the extension of the OPEC/Russia oil output cuts until the end of 2018. Since the agreement, initiated by the Organization of the Petroleum Exporting Countries (OPEC), started in November 2016 to get rid of excess supply, Brent crude prices have risen in seven out of the last nine months and so far have increased by more than 4% this year. However, the surge in the US exports to Asia might start offsetting these cuts.
Finally, demand is expected to be strong – the world economy will continue to grow for the next two years at least. The International Monetary Fund (IMF) revised up its projections for the global economic growth in 2018 and 2019 by 0.2% to 3.9%.
What Could Make Prices Fall
What could lead to an oil price drop in 2018 is the sudden decrease in demand (if another global economic downturn starts) or a further rise in supply. For example, an early finish of OPEC and Russia production cut deal to stop the US from taking their market share, could flood the market again and start a price war, making oil production unprofitable.
The risk of the US oversupplying the energy market is high. The total active US rig count, one of the main indicators of the state of the US energy market, rose by almost 18% from last year’s count to 1,032, according to Baker Hughes (155 new rigs compared to last year). This
shows constant growth.
Amid tensions with OPEC members, it is very unlikely that the US will agree to any production cuts on its side. As the country will cover most of the global demand over the next three years, the US output is one of the leading factors that will determine the price of oil and could well reduce it.
This post first appeared on The Market Mogul.
