IMF Says the Logic Has Shifted
After oil prices plummeted 65% between June 2014 and now, it became clear that the industry was undergoing structural changes. The tectonic shifts are posing a serious challenge for analysts who need to forecast oil price movements over the next 12 months.
Or at least that’s according to Rabah Arezki, the Chief of the Commodities Unit at the International Monetary Fund (IMF). Arezki wrote a brief piece summarizing the problem. (Source: “Rethinking the Oil Market,” Project Syndicate, October 10, 2016.)
In the 2000s, high demand for oil drove a rapid expansion in supply. Projects that were traditionally unaffordable became feasible as prices climbed above $80.00, and later $100.00, per barrel. Moreover, the U.S. shale boom unlocked huge deposits that were previously untapped.
That supply bump paved the way for greater energy independence in the U.S., but it also transformed the underlying dynamics of oil prices. Rather than cutting supply to combat falling prices, the Organization of Petroleum Exporting Countries (OPEC) deliberately prolonged the low price environment.
“At a November 2014 OPEC meeting, Saudi Arabia blocked a motion by other members to reduce production in response to falling prices,” writes Arezki. “The Saudis have instead boosted output, resulting in immense pressure on higher-cost non-OPEC producers.”
In other words, Saudi Arabia is using OPEC to crush the industry’s most expensive producers of oil, most of whom exist in North America. Arezki goes on to say that might be a difficult goal to accomplish because shale-oil projects have grown more efficient and have a shorter lead time. They move quickly from initial investment to production.
“One defining feature of the ‘new oil market’ brought about by the advent of shale oil is shorter, more limited oil-price cycles,” he continues. “Indeed, shale-oil production requires a lower level of sunk costs than conventional oil, and the lag between first investment and production is much shorter.”