Cheap Oil As the New Norm ‘Misguided’
Crude Price Futures May Depend on Performance of U.S. Shale Industry
“While it may be true that oil prices have yet to bottom out, expectations that cheap oil are the new norm are misguided. Predictions of long-term low oil prices will likely prove as wrong as the assumptions…of sustained, stubbornly high prices turned out to be.”
Those were the conclusions of Antoine Halff, a Columbia University researcher, in testimony given earlier this month before the U.S. Senate Committee on Energy and Natural Resources.
“As in previous oil market cycles,” Halff added, “a price correction is inevitable.”
Sitting at the tipping point of global oil pricing, according to Halff, is the U.S. shale oil industry. With zero production just a few short years ago having grown to 4.5 million barrels per day, U.S. shale oil is responsible for the glut of supply on global oil markets and the consequent collapse of prices.
The drop in prices has counterintuitively led traditional oil exporters in the Middle East and elsewhere to ramp up production, primarily, according to Halff, in order to be able to keep up social spending which keeps their countries’ populations in line.
This ramp up in production has in turn, pushed prices down even further, and finally, had the effect of reducing U.S. shale oil production, by an estimated 700,000 barrels per day this year.
Shale oil extraction operations differ from traditional methods in that up-front costs and time to get production started are foreshortened from years to months, potentially positioning the U.S. shale industry as the fulcrum of global oil markets, with the ability to ramp up and scale down production in reaction to market forces.
“While many factors on both the current supply and demand situation conspire to create the market’s massive imbalance and a consequent buildup of global inventories,” said Hallf, “the resulting bearish pressures on oil prices are unsustainable.”
Shale oil was the first to respond to the price decline, and could again be the first to take advantage of an upswing in oil prices. “Whether the shale oil industry will in fact retain its full capacity to rebound through the downturn is highly uncertain, however,” said Hallf. The industry’s access to capital may be degraded thanks to interest-rate hikes ad its access to labor may also suffer due to the recent industry layoffs.
“Restructuring and consolidation in the shale oil patch may also lead to changes in the management of shale oil assets if they are acquired by larger companies with more diversified portfolios and different interests than the current owners,” said Hallf.
“Downward pressures on oil prices will persist until the market reaches an inflection point and inventories decline,” Hallf concluded. “But the factors that today incentivize producers to boost output at the expense of longer-term investment will inevitably undermine future production. The very rise of the shale oil industry, with its unique cost structure and short business cycle, undermines longer-term investment in high-cost conventional supply.”
This ability of the shale industry to increase production in reaction to a rebound has yet to be tested, however. “The market might find out when prices finally recover that its capacity has been durably degraded,” said Halff. “In a best-case scenario, the market ought to brace itself for a period of heightened volatility…Alternatively, low prices today may set the stage for significant supply shortfalls tomorrow.”