Crude’s six-month lemming plunge seems to have ended. But the factors that caused it in the first place haven’t gone away.
- By Keith JohnsonKeith Johnson is Foreign Policy’s acting managing editor for news. He has been at FP since 2013, after spending 15 years covering terrorism, energy, airlines, politics, foreign affairs, and the economy for the Wall Street Journal. He has reported from Europe, the Middle East, Africa, and Asia and, contrary to rumors, has absolutely no plans to resume his bullfighting career.
Crude oil prices, which have rattled petrostates by plunging 60 percent from their summer 2014 highs, are suddenly leaping back up. Prices for benchmark crudes have jumped about 15 percent in the last week, and they continued to do so early Tuesday, Feb. 3, with Brent crude futures closing in on $58 a barrel in London.
It appears that oil prices finally found their floor, after months in which analysts raced to slash oil-price forecasts and worried oil-producing states vied with each other to paint ever-more-dire pictures of plunging crude. The uptick promises some measure of relief for the countries, from Russia to Venezuela, that have been battered by the collapse in crude prices in recent months; both those two countries suffer soaring inflation and roaring budget deficits. But the nature of the rebound also offers a cautionary word about why it’s happening — and suggests there will be more, not less, market volatility in the months to come.
Oil prices aren’t rebounding because the world has suddenly run short of the stuff, nor have the lower prices spurred any major uptick in demand for oil: There is still more oil sloshing around the market than there are purchasers waiting to snap it up. But the sudden, deep collapse in oil prices at the end of last year appears to have hit the industry harder and faster than many expected. That, in turn, has led to cutbacks in planned investment, canceled exploration projects, and disappearing drilling rigs around the world, all of which leave oil traders nervously thinking about what lies ahead.
The number of drilling rigs operating in U.S. oil and gas fields is an especially telling indicator. The rig count had been falling since the end of last year, but has now gone into free-fall. Last Friday’s decline in operating rigs — 94 were pulled offline — was the biggest in nearly 20 years, terrifying the oil market and sending oil prices rising 8 percent in a single day.
In a way, that makes sense. Unlike traditional, decades-long oil-extraction projects like those in the Middle East, U.S. tight oil and shale gas operations are quick to ramp up and quick to scale down. That’s because they require the constant drilling of new wells to maintain production levels, while an old-school oil field, once started, will pump for years. Indeed, in the wake of oil’s free-fall, many officials inside and outside OPEC hinted that the idea was to make life difficult for U.S. producers that have flooded the market with crude, though most analysts expected that it would take longer to have a serious impact on U.S. wildcatters.
“The truth is that U.S. shale production can be turned on and off almost immediately, and this represents a dramatic novelty for the oil market,” wrote Leonardo Maugeri, a former executive at Italian oil firm Eni and now at Harvard University’s Belfer Center, in a recent research note.
But it’s not just the rapid-response U.S. operators that are pulling in their horns. Big global energy firms are also rapidly scaling back investment plans in the face of lower prices. Outfits such as BP, Shell, Total, and Chevron have all recently announced plans to slash their capital expenditure budgets this year or spike particular projects. Together, they’ve trimmed at least $35 billion in planned investments.
Asia’s state-owned giants are also reeling and battening down the hatches. China’s CNOOC and PetroChina and Malaysia’s Petronas, for example, have all slashed spending plans. Even big Middle Eastern producers, whose insouciance and inaction in the face of a growing supply glut late last year fueled the price drop, are feeling the pinch: Saudi Aramco just axed plans for ambitious projects in the Red Sea.
This sort of reaction was always a potential wild card: Oil-market analysts and executives had warned that falling prices that caused curtailments in spending would by themselves help push oil prices back up. Indeed, that’s just what Chevron boss John Watson said would happen.
But the big, if unanswerable, question now is how the industry reacts to the reaction. That is, if prices go back up, U.S. tight oil and shale operators will be better placed to resume drilling operations. And that, in turn, could slow down the charge of oil bulls.
Either way, prices aren’t likely to get anywhere near last summer’s highs because of the continued, fundamental mismatch between global oil supply and demand; some prominent Saudis have said that the days of $100 barrels of oil are history. Seen from that vantage point, the oil-price gains of recent days could simply be a dead-cat bounce.
Some huge oil producers, such as Saudi Arabia, Iraq, and Russia, have kept the spigots wide open despite lower prices. Russia, despite war in Ukraine, Western sanctions, and a collapsing ruble and oil price, reached a post-Soviet oil-production record last year and aims to match it this year. OPEC increased production by 140,000 barrels a day in December, despite cratering prices. While Saudi Aramco pulled the plug on the tricky and expensive Red Sea operations, it is increasing its capital expenditure in other areas.
The big difference with other periods of whipsawing oil prices is the shifting nature of the business and the players. U.S. tight-light-oil producers, in places like Texas and North Dakota, have become the default swing producers for the global oil market, reprising a role their forerunners once played in the late 1960s. They are reclaiming the mantle from the Saudis, who for years were called upon to ratchet up or throttle back production to stabilize the global oil market virtually single-handedly. (But the Saudis have been desperate to shed that burden and make other oil producers share the pain.)
That is to say, the growing importance of the U.S. tight-oil sector — and its ability to react quickly to both price declines and price increases — points the way to more ups and downs in the market, rather than anything resembling a smooth ride.
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