Advertisement
Features

It looks like we’ve reached stalemate in the oil price wars

The oil price has refused to budge despite oil cartel Opec and Russia cutting back on production. John Stepek explains why, and looks at what that means for investors.

17-5-30-Opec-634
Try as it might, Opec is struggling to raise the price of oil

© 2017 Bloomberg Finance LP

A couple of weeks ago, oil producers of the world decided to do "whatever it takes" to "rebalance" the oil market.

In other words, they are worried that prices are getting too low, and so they wanted to cut back production to make sure they don't fall any further.

At first, the market took the bait. Oil prices bounced strongly as oil cartel Opec and big producer Russia announced plans to extend production cuts.

Advertisement - Article continues below

But now that the cuts have been confirmed, oil prices are looking distinctly droopy again.

The oil market stalemate

That's unusual. Normally, you get a fair bit of "non-compliance" everyone stabbing each other in the back as they take advantage of lower competition from their rivals.

So they've been very well behaved this time around. Has it helped? Not really.

The market was unimpressed overall. Prices in the US dipped back below $50 a barrel. It's partly because the news had been expected. But it's also because investors are waking up to the fact that Opec can only do so much.

"While stockpiles are shrinking", reports Bloomberg, "ministers acknowledged the surplus built up during three years of overproduction won't clear until at least the end of 2017."

Here's the fundamental problem for Opec members and any other country whose economy has been relying on eternally high oil prices to keep them afloat: US shale oil.

Advertisement - Article continues below
Advertisement
Advertisement - Article continues below

Opec got careless and greedy, as everyone does during the good times. While most other countries were struggling after the 2008 financial crisis, oil producers were doing just fine.Oil at $100 a barrel looked like a nice round number. The price had stayed above that number for so long. Why not take advantage of it?

But the problem was, at $100 a barrel, it made lots of sense for any small producer with ambition and a patch of shale to have a crack at getting it out of the ground. Better yet, with interest rates at near-0% (as a direct result of said financial crisis), there was nothing stopping them from raising the funds to do so.

If oil prices had fallen early enough during the shale discovery process, then the industry could have been killed off, no doubt about it. If oil had gone back down to $20, or maybe even $40 a barrel, a good while ago, then it's possible that US shale producers would have given up.

Advertisement - Article continues below

But eventually, a tipping point was reached. Money was riding on projects being successful, and others had gone past the point of no return. So even when oil prices fell, it made sense to continue pumping out oil to generate cash to repay interest on loans.

With margins being squeezed, it made sense to ramp up investment in technology in order to improve the break-even point. And with shale producing excitement, jobs and growth not to mention the idea of energy security in an otherwise troubled economy, it became politically important too.

So Opec allowed an industry to grow right beneath its nose, and it's now too significant to be killed off.

Advertisement
Advertisement - Article continues below

As Eoin Treacy puts it on FullerTreacyMoney.com, "US onshore unconventional supply is now an important global swing producer and is economical around $60".

What does this mean for investors?

I imagine we'll also see a lot of central-banker-style "jaw-boning", with Saudi Arabia in particular, acting to talk up the market any time it looks as though prices are going to slide.

Advertisement - Article continues below

But at the same time, if you've got shale oil producers ramping up production, then it's hard to see how prices can go a lot higher. The number of rigs in use in the US bottomed out a year ago almost to the day.

Now they're climbing steadily the week before last saw the 19th week in a row of gains and that's unlikely to slow down if US shale producers believe that Opec is now keen to put a floor under the price.

So for now, let's assume that oil prices are stuck in a rough range. They might not drop sharply, but it's hard to see a scenario in which they rocket higher either.

In terms of the bigger picture, less volatility in the oil price is a good thing for the global economy. As a consumer country, we like cheaper oil. The producers might not be so happy, but if oil is roughly where it is, they can mostly get by.

As for investors, oil companies that made it through the carnage of the crash are probably more comfortable now with prices around where they are now (or preferably a bit higher). A much bigger concern just now, of course, is the furore surrounding oil services giant Petrofac but we'll have more on that in MoneyWeek magazine this week. (If you're not already a subscriber, sign up here.)

Advertisement
Advertisement

Recommended

Visit/520272/iran-and-us-oil-price
Global Economy

What escalating tension between Iran and the US means for oil prices

The tension between the US and Iran is unlikely to mean all-out war in the Middle East. But markets may be getting a little too complacent about its e…
6 Jan 2020
Visit/519785/rising-output-will-keep-a-lid-on-the-oil-price
Oil

Rising output will keep a lid on the oil price

Oil exporters’ cartel Opec gave further encouragement to the bulls this month after agreeing to new production curbs.
20 Dec 2019
Visit/519858/how-long-can-the-good-times-roll
Economy

How long can the good times roll?

Despite all the doom and gloom that has dominated our headlines for most of 2019, Britain and most of the rest of the developing world is currently en…
19 Dec 2019
Visit/518797/brace-yourself-for-pricier-oil
Oil

Brace yourself for pricier oil

Global growth, and hence demand for oil, could surprise on the upside next year, leading to a bounce in the oil price.
29 Nov 2019

Most Popular

Visit/investments/stockmarkets/601460/disease-rioting-and-mass-unemployment-so-why-are-markets-soaring
Stockmarkets

Disease, rioting and mass unemployment – so why are markets soaring?

Despite some pretty strong headwinds in the last year, America’s S&P 500 stock index is close to all-time highs. John Stepek explains why markets seem…
4 Jun 2020
Visit/investments/commodities/gold/601444/these-seven-charts-show-exactly-why-you-must-own-gold-today
Gold

These seven charts show exactly why you must own gold today

Covid-19 is accelerating many trends that were already in existence. The rising gold price is one such trend. These seven charts, says Dominic Frisby,…
3 Jun 2020
Visit/economy/eu-economy/601463/why-a-stronger-euro-is-good-news-for-investors
EU Economy

Why a stronger euro is good news for investors

The fragile state of the eurozone has for a long time brought the threat of deflation. But the ECB’s latest moves have dampened those fears. John Step…
5 Jun 2020