New Stage in the Global Oil Price Cycle?

New Stage in the Global Oil Price Cycle?

2018 opened with the global oil price reaching its highest point since it crashed three years ago, topping $70 a barrel for most of January and early February. The price has since retreated to around $65 a barrel, but there are strong indications that oil will trade in a higher band this year than in the previous three. The US is also poised to emerge this year as the world’s top oil producer. In light of this change and other international energy developments, Washington should reevaluate some of its long-standing energy policies, including its maintenance of the Strategic Petroleum Reserve in its current form.

While pundits and policy makers often look to identify invisible forces moving the oil market, the causation is simple: supply and demand. On the demand side, global economic growth is accelerating around the globe, leading to greater demand for energy to fuel the increased economic activity. As a result, the world is edging toward consumption of 100 million barrels a day.

On the supply side, a number of suppliers are challenged to maintain their production levels, notably Venezuela. Venezuela’s oil output is currently nearing a 30-year low. Further geopolitical insecurity lies in in the Persian/ Arab Gulf region. Potential domestic political instability in both Saudi Arabia and Iran looms alongside the protracted conflict between the two states that has manifested itself both directly and through proxies, such as Yemen. However, the global oil price does not reflect geopolitics alone. Geopolitical events only significantly influence the market when it is a tight oil market — when supply and demand are close. In addition to the increased – and likely increasing – demand, the rise reflects the fact that few significant production investments were made during the period of low prices. With declining volumes of oil in storage around the world, the market has tightened, heightening the sensitivity of prices to world events.

In what direction are prices headed? On the one hand, higher prices are stimulating significant increases in North American production, which will moderate future prices. On the other hand, there is not much new oil volume coming on-line elsewhere and some existing supplies are under threat.  As a result, analysts are divided over whether increases in U.S. production of shale oil will be sufficient to meet the anticipated long-term rise in demand. In the short term, other economic factors are affecting the price of oil. For instance, since oil is traded in dollars, changes in the price of the dollar have led to fluctuations and adjustments in the oil market. When the dollar is weak versus foreign currencies, foreign entities tend to buy more oil since exchange rates make it cheaper to do so.

Looking beyond the immediate future, factors of the global oil market to monitor include reports on economic data around the world, especially growth trends in major markets; the physical state of oil inventories; and the potential for renewed domestic instability in Iran, which may only have subsided for a period. OPEC’s policy impact on the market seems to have been overestimated in recent years, given that oil prices rebounded not as a result of OPEC policies, but due to market fundamentals and renewed economic growth.

In studying the global oil price, it is important to remember that oil prices are cyclical. What is here and now is not here to stay. The cycle may be getting shorter, due to the quicker response time from US shale production than conventional oil to the new price signals, but it is not going away. 

In parallel, the relative power of different players in the oil market is undergoing a structural rather than cyclical shift:  the US is poised to become the world’s top oil producer, recently reaching the 10 million barrel-a-day mark and outpacing Russia and Saudi Arabia.  The last time the US produced more oil than Saudi Arabia was in 1970. As a result, oil price changes now have a mixed impact on the US economy. Prior to the last decade, the rise in the oil price generally inhibited growth and could threaten recession. Today, with the US being a major oil producer, the rise has a dual effect as American oil companies and businesses in the oil producing regions thrive, while consumers pay a higher price at the pump.

Still, given the recent changes, maybe it is time to re-think the Strategic Petroleum Reserve. The reserve was established in response to fears of scarcity following the 1970s oil crisis. With the US awash in oil and possessing a “virtual strategic reserve” in the form of shale oil, perhaps the existing physical reserve is no longer needed. Washington has not conducted a serious policy evaluation of the utility of continuing to maintain the Strategic Petroleum Reserve, or at least at its current level. In the age of US “energy dominance,” the time has arrived for a review of the Strategic Petroleum Reserve.

 

Prof. Brenda Shaffer is a visiting researcher and adjunct professor at Georgetown’s Center for Eurasian, Russian and East European Studies. She is also a Senior Fellow at the Atlantic Council’s Global Energy Center. Her book Energy Politics serves as a text book in over 200 university courses around the globe. Prof. Shaffer has given testimony to several committees of the US Congress, including the Senate Foreign Relations Committee, and to the European Parliament on energy issues. She frequently appears on CNBC and in major news outlets worldwide to provide insight on developments in the global oil market.