Oil Production Is at Record Levels. So Why Are Oil Prices Heading Higher?

The short answer: Looming shortfalls from Venezuela and Iran.

By Keith Johnson, a senior staff writer at Foreign Policy.
A pumpjack in the Permian Basin in Texas, which has made the U.S. the world’s biggest oil producer, on Jan. 21, 2016. (Spencer Platt/Getty Images)
A pumpjack in the Permian Basin in Texas, which has made the U.S. the world’s biggest oil producer, on Jan. 21, 2016. (Spencer Platt/Getty Images)

The world is now pumping and consuming more oil than it ever has, with output from big producers such as the United States and Saudi Arabia at or near record levels. But oil prices are still stubbornly high, and lots of barrels from Iran and Venezuela are all but certain to disappear from the market in the weeks to come. That means the world needs to find a way to keep the economy supplied with oil or risk even higher prices right as global economic headwinds are intensifying.

In August, for the first time in history, the world pumped more than 100 million barrels a day, according to a new report from the International Energy Agency (IEA). That was fueled by a continuing gusher from the U.S. shale oil patch—which has apparently turned the United States into the world’s largest oil producer, with the country pumping almost 11 million barrels a day—and a rebound from OPEC, which is pumping more than it has all year.

But the record production is barely enough to keep up with the world’s thirst for oil. Demand from developing economies, especially in Asia, is still strong and is expected to grow at the same pace next year. Refineries are churning out record amounts of gasoline, diesel, and other products, and even tapping already-low crude stocks to do so.

For that reason, crude oil prices remain quite high: Brent crude in London is about $80 a barrel, and U.S. crude is about $70 a barrel, both about 45 percent higher than this time last year.

“A few years ago, people were saying, the era of easy and cheap oil is over. Then the shale boom changed the market,” said Antoine Halff, formerly the chief oil analyst at the IEA and now a senior research scholar at Columbia University’s Center on Global Energy Policy. But global thirst for oil has continued unabated, and prices have steadily crept back up.

“We do have a market where shale is the biggest source of growth, but nevertheless we’re still facing the possibility of significant price increases next year,” he said.

It could happen even sooner. A lot of oil is about to disappear from the market, and it’s not clear how easy it will be to replace it, which could push crude prices higher, increase pain at the pump, and act as a brake on global economic growth.

While OPEC has re-opened the taps this year, two of its members are set to lose ground as big suppliers. Venezuela’s oil industry, wracked by political interference, mismanagement, and under-investment, has gone from dismal to catastrophic. Production was at 1.5 million barrels a day this spring but is expected to drop to 1 million barrels a day by the end of the year.

Iran’s oil exports are set to decline for a different reason: U.S. sanctions will go into effect in November. The Trump administration wants buyers of Iranian oil to quit cold turkey, and fearing punishment from Washington, many in Europe and Asia (except China) are sharply cutting their imports of Iranian oil.

The IEA estimates Iranian exports have already fallen by 500,000 barrels a day and could fall sharply by November as other customers comply with the U.S. request. One big wildcard is whether China and India—Iran’s top two customers—scale back purchases or keep snapping up Iranian oil to meet their own needs.

Which country can make up that shortfall of more than 1 million barrels a day for the global market? It’s not entirely clear, according to the IEA. Infrastructure constraints are starting to limit the United States’ ability to keep growing. Brazil’s promised output increases have yet to materialize. Russia says it can pump as much as 300,000 more barrels a day, but likely not until next year. Many OPEC members, such as Iraq, Nigeria, and Libya, have already nearly maxed out their production. That likely leaves Saudi Arabia and a handful of other traditional suppliers.

The IEA estimates that OPEC, especially Saudi Arabia, has potential spare capacity of 2.7 million barrels a day, representing the amount of production countries could theoretically bring on line within a few months to ease the market.

But the IEA doubts all that can be brought to market quickly, and at any rate, that oil is not a perfect replacement for the heavier Iranian and Venezuelan barrels that are disappearing.

“We are entering a very crucial period for the oil market,” the IEA concluded in its monthly oil report. “Things are tightening up.”

A tighter market would likely push already high oil prices even higher. While the global economy, and especially the U.S. economy, have been humming this year, higher oil prices would only add to the storm clouds that are piling up.

First, there is the U.S.-China trade war, which is poised to intensify with further rounds of U.S. duties on essentially all Chinese imports. There are already indications that trade tensions are starting to weigh on the economy.

Global shipping rates are falling on fears for trade. U.S. firms are reporting more concerns about tariffs and starting to freeze investments, according to a new report by the Federal Reserve Bank of Philadelphia. Investment banks that have been bullish on economic prospects so far are starting to caution that trade tensions could weigh on growth, in the United States and around the world.

And China has worries beyond the escalating trade war. Debt levels are extremely high, and investment is at 20-year lows, raising concerns of a broader slowdown in the world’s second-largest economy.

Emerging markets are also getting battered, suffering their worst slump in years. They face both fears of the global trade contagion and rising interest rates in the United States, which makes it even harder for those countries to repay debts with currencies that are worth less and less.

Then there are the ghosts of the last financial crisis, which exploded 10 years ago this week. Ominous indicators abound that the world hasn’t heeded the lessons of that crisis. Personal debt has skyrocketed in the United States—to levels higher than they were when the financial meltdown began. U.S. corporate debt, too, has exploded to record levels, and much of it is close to junk status; many corporations are in worse shape than in 2008. The mortgage market is booming again at decade-ago levels.

To head off higher oil prices, especially right ahead of crucial midterm elections in the United States, the Trump administration could further tap millions of barrels of oil in the country’s strategic oil reserves. The White House already announced it would release a modest amount of oil through the end of the year, partially to comply with congressional requirements to sell the oil stocks and partially to cushion the impact of the Iran sanctions.

More moves, including a coordinated release with other big oil-consuming countries, could be in the cards.

Halff said the IEA’s concern about the market’s ability to fully make up the shortfall from Iran and other countries “opens up the possibility of a coordinated release” among other members of the IEA. But he added that it might be tough to persuade countries angry at the Trump administration’s stance on Iran to take coordinated measures to blunt the political impact of those very sanctions.

Keith Johnson is a senior staff writer at Foreign Policy. Twitter: @KFJ_FP