What’s Behind the Rise in the Price of Oil?

Back in the day, before hydraulic fracturing or “fracking” and the Shale Gas and Oil Revolution, the U.S. imported a lot of crude oil from Saudi Arabia and other Middle Eastern countries, as well as North African nations and Venezuela. In those days that weren’t really very long ago, U.S. oil production was down to about five million barrels per day. And anytime there was any sign of unrest in the Middle East or North Africa, crude oil prices would spike. Analysts would comment that oil traded on “headlines” instead of “fundamentals,” and that was largely true.

Then came the U.S. shale revolution, writes Thomas J. Tubman, and everything changed. Production in the U.S. more than doubled. Currently it is in excess of ten million barrels a day, and it could reach eleven million barrels a day by year end. As a result of skyrocketing oil production in the U.S. (and more broadly in North America—production in Canada has taken off, and Mexico looks to be next) and as global oil inventories rose, geopolitical events in the Middle East became less important to crude oil prices in recent years.

But 2018 has seen a steady rise in the price of oil (up 50% or so) and at this writing NYMEX crude has surpassed seventy dollars a barrel for the first time since 2014. You might ask: What has changed? Well, actually several things. Seldom does one factor or event cause a major shift. It usually takes multiple events.

Where should I start? How about OPEC! For the last couple of years, OPEC, along with several other non-OPEC oil-producing countries, including Russia, have tried to limit production in an effort to reduce the worldwide glut of oil and support price. Few believed that the coalition would hold together and succeed, but it appears that it has, and inventories are coming down. As prices rose, many expected the shale producers here in the U.S. to ramp up quickly to counteract OPEC’s success in supporting price. That has been the trend in past years when shale producers demonstrated their ability to react quickly and add significant barrels to supply and hold prices down. But that didn’t happen this time. The reason seems to be investors who are looking for better returns. They appear to be putting pressure on shale producers to maintain discipline and focus on returns over growth. Venezuela is also a major factor. That nation’s socialist economy is spiraling down much faster than predicted, causing oil output there to plummet. Worldwide demand for oil is also rising a bit faster than expected due to strong economic growth here in the U.S. and elsewhere. And there are other factors and events that also contribute to the rise in crude oil prices. The latest is the Trump decision to withdraw from the Iran Nuclear Agreement, or the JCPOA (Joint Comprehensive Plan of Action). The U.S. withdrawal and the expected re-imposition of sanctions is expected to take 700,000 barrels off the market, and this is now factored into the premium on global oil prices.

With regard to the potential loss of Iranian oil, Saudi Arabia has vowed to fill the void.  But analysts predict that would set up a major contest among other producers who have agreed to dial back production to reduce oversupply in support of price, Russia being one of the producers likely to lead that charge. All producers have taken a pay cut in recent years as crude prices have retreated, and Russia’s president, Vladimir Putin, as much as anyone, needs the additional cash to support his political aspirations. Russia, at a production level of about ten million barrels a day, sees a ten-million-dollar-a-day premium or deficit for every dollar change in the price of crude (a ten-dollar swing means one hundred million dollars a day, up or down, for Russia).

So, what does the next year hold in store? No one knows for sure.  But if recent history is any guide, U.S. shale producers are likely to increase production, albeit in a more financially responsible manner, and offset any reductions coming from Venezuela and or Iran, and the OPEC alliance is likely to grow weary of the production cuts and the reduced income, and likely to begin to cheat on quotas, as they have a history of doing, and in the wake, prices are not likely to continue to rise.

Thomas J. Tubman is the executive director of the American Energy Coalition, which promotes the benefits of oil heat in
comparison to other energy sources, particularly natural gas.