The Crude Truth About the Oil Market

Global oil prices are on the move again. Market watchers would be quick to say that that’s nothing new, given swings that can occur on a daily or weekly basis. But the recent $8 drop in West Texas Intermediate crude revived fears that a steeper drop could be in the works. Producers don’t seem satisfied that the recent range will hold; no doubt they are jaded by the wide gyrations of the past three years – or longer. At the same time, a broader audience is looking at the effect of crude oil’s latest movements on our dollar, and wondering where things are headed. Are prices settling into a range, or can we expect further shifting?

If the past two decades have taught this industry something, it’s that price forecasts are very hard to get right. Careers have been established – and obliterated – by crude price calls. Fifteen years of price stability at the mid-$20 level stretching through 2002 duped analysts into believing the industry had achieved some sort of ‘new normal’. The unabated price runup that followed changed that thinking, with the focus switching to the insatiable demand of emerging markets. Zap forward to late 2007, and the ‘new normal’ was more like $100. Then it got really wild. Prices rocketed up to $150 by mid-2008, and the calls for $200 by year-end started to come in.

The Great Recession put paid to those calls. Red-faced pundits had to concede that the early-2008 spike was momentary, as they drafted together a set of reasons explaining the year-end price of just $35. Funny thing, for a brief moment, that level was tagged as our new reality. Prices did revive in short order, though, rising to a more defensible $75 per barrel and staying there for a little over a year. What then happened came as a bit of a shock: despite weakened post-recession demand, prices moved back into the $90-$100 range, and stayed there for three-and-a-half years. That kind of stability convinced market watchers that this indeed was the ‘true new normal’ that had eluded us. Others concluded that if tepid world growth could yield these sorts of prices, that eventual revival would push them even higher. The bulls were out again!

What then happened was, in general, a shocker. Prices plunged precipitously from mid-2014 to a shocking $25 per barrel in January, 2016. They revived to the $50 range by mid-2016, a relief for the industry, but a level that still required a lot of adjustment. Prices looked stable until recently (oh no – not another ‘new normal’?). So…where to from here?

For some perspective on the two-decade roller-coaster ride, a little history. The price rise in the early 2000’s was likely spurred by a combination of emerging market demand and adjustments in developed markets’ consumption patterns brought on by low prices. The price spike was fed first by broad fears that supplies were structurally short, with no near-term remedy, and then by market speculation. Recession fixed those fears, but only briefly. Stimulus – initially government spending, and then quantitative easing (QE) – re-ignited prices and kept them artificially high through mid-2014. The return of growth ended the need for QE, and as the taps were turned off, a key support for commodity prices was removed. The market was left to fend for itself, and in the freefall, one by one market attempts to support prices failed.

Why? High prices spurred lots of investment in technology and key projects around the world. As output increased, it became obvious that supply was once again well ahead of demand, as far as anyone could reasonably see into the future. It now seems that US shale is the global swing producer, with lots of supply ready to come back into market at about the $60 level. Behind that are other global projects and investment plays, delayed for now but ready for the green light if prices rise. That sounds a lot like an argument for the current range being a new normal. Well, it may persist for awhile, but if we are right in thinking that there is near-term upside potential for global growth, then upward revisions to demand – and prices – would naturally follow.

The bottom line?

Crude oil prices are likely range-bound in the mid-$50 per barrel range for now. Our forecast calls for an average of $54 this year and $57 in 2018. As such, we believe the recent swoon to be short-lived. But today’s range is no new normal. The current upshift in global demand will ultimately do the same for crude prices.

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