Oil producers are pumping harder – but don’t expect oil prices to slide

published 25 June 2018

180625-oil — Opec and Russia are increasing production

This weekend, Saudi Arabia ended its ban on women driving.

This is great news, obviously. Far be it from me to comment on another country's internal affairs, but effectively excluding half of the population from full participation in society is not only tyrannical and wrong, it's also not very sensible economically.

According to analysis by Bloomberg, the end of the driving ban will help to increase the number of women working, boosting household incomes, and eventually adding more wealth to the economy than the planned listing of the state-owned oil company.

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Another beneficial side effect, noted Saudi Arabia's energy minister, is that demand for petrol will go up.

Which is convenient, because Saudi Arabia and its chums in the Opec oil cartel have just decided to start pumping more oil.

Opec and Russia are pumping out more oil

Opec, the Saudi-led oil cartel, and Russia have decided to raise oil production by up to a million barrels a day.

Just to recap, Opec and Russia agreed with each other to reduce production back in 2016. The goal was to underpin a collapsing oil price. You could argue that it worked, or you could argue that oil prices had fallen so far and so hard that they were due a bounce. But whatever the reality, the oil price bounced back.

And the oil producers managed to both agree the cuts and stick to them, which is highly unusual (they usually pretend they're going to cut and then keep pumping as much as they can).

Now of course, oil has rebounded sharply, with Brent crude (the European benchmark) getting as high as $80 a barrel recently. This year has seen a particularly noticeable rally, and that's started to get people a bit jittery about the implications of higher oil prices.

US president Donald Trump has a mid-term election to contest later this year. If there's one thing US voters hate to see, it's rising petrol prices. Americans are particularly sensitive to rising oil prices because they don't pay much tax on their petrol. As a result, any move in the crude price has a much more dramatic impact on the price at the pump. So he'd like to see lower prices.

Meanwhile, although Saudi Arabia and Russia might enjoy higher oil prices while they last, they're also keenly aware that high prices are what creates lower prices. The higher prices go, the harder companies work to get oil out of the ground. The higher prices go, the harder people work to find alternatives. The higher prices go, the more Teslas get bought, the more money goes into battery research and building better wind turbines you get the picture.

So there's a longer-term logic to increasing production now. If you can hold the oil price at a steady $70 for now, then some of the heat is taken out of the market and a lot of the political and economic pressure around it will dissipate.

Also, Saudi Arabia and Russia are the main beneficiaries of any increase in production in any case they're pretty much the only ones with the capacity to do so. For example, Iran the third-largest producer in Opec had objected to raising production. But there are two obvious reasons for that. Firstly, Iran and Saudi Arabia are regional rivals, engaged in various proxy wars across the Middle East. Secondly, Iran can't take advantage of any production increase. Its own oil exports look set to fall this year after the US reimposed sanctions on the country.

The US oil producers have a problem not enough pipes

Anyway does this mean oil prices are set to slide?

I wouldn't bet on it. One reason to be sceptical is that, in reality, there will probably fewer than a million barrels a day added. A number of Opec members beyond Iran are in no position to raise production, notably Venezuela.

Another reason is that US shale oil supplies may not be in a position to keep growing at their recent dramatic pace. For example, one of the most important shale oil areas is about to hit a wall. The Permian region (which is located across west Texas and New Mexico) is running into capacity problems, according to Bloomberg. The issue is not that the region is running short of oil, the problem is that it's running out of pipelines to get the oil from the shale fields to its customers.

According to the newswire, "the problem has grown so bad that oil companies have been forced to load crude in to trucks and drive it hundreds of miles to pipelines in other parts of the state."

Pipeline capacity stands at around 3.6 million barrels a day, and production is now at 3.3m barrels. Further pipelines are in construction, but according to Scott Sheffield, the chairman of Pioneer Natural Resources, they won't be ready until next year at least. In other words, US oil production is also restricted.

In all, unless there's a slowdown in the global economy, then demand may well keep up with supply increases. A slowdown is, of course, by no means uncertain, indeed it's inevitable at some point but the key is those last three words, "at some point".

Between now and then, I'd expect oil to stay roughly where it is, or possibly trend higher. If you want to know more, MoneyWeek regular Max King looked at some of the best ways to play the recovery in the oil price in a recent issue of the magazine.

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.