The Global Oil Market: No Safe Haven for Prices

Introduction

In 2012, evidence suggested that a collapse in oil prices by 2015 was quite possible and that the duration of such a collapse would depend essentially on how quickly the massive worldwide investment in new production capacity could be stopped.[i] For multiple reasons, halting ongoing investments in the oil industry is particularly difficult.[ii] After a decade (2005-2014), the investment super-cycle of 2010-2014 started bringing online new production capacity and slowed the rate of decline of mature oil fields. Almost all big oil producers registered significant output growth, with the United States and Iraq leading the way, whereas demand growth was insufficient to absorb the increase of production. From July 2014 on, oil prices reflected this imbalance as they started to decline constantly after staying higher than USD 100 per barrel for several years. Finally, in November 2014, they collapsed when Saudi Arabia essentially imposed a policy of no production cutbacks on the Organization of Petroleum Exporting Countries (OPEC).

In 2015, prices fell by more than 50 percent, and the collapse continued in early 2016. In the third week of January 2016, oil prices fell below USD 27 per barrel, the lowest level in 13 years.

Despite the decline in price, actual production of oil seemed to defy the laws of gravity and economics as it continued to grow. Once again, the main reason for this apparent contradiction is that while many companies and countries announced cuts to their spending budgets, very few actually halted investments already under way in the upstream sector. Many are just beginning to register production from recently completed investments, while others are completing their investments, after having spent the bulk of their capital budgets. The result: production capacity and the supply of oil will continue to grow.

Oil producers hope that in 2016, the demand for "black gold" will rise enough to clear at least some of the excess that has been created. This seems unlikely. Consumption will almost certainly increase, but not realistically to the levels necessary to eliminate excess production, which has reached almost three million barrels per day (mbd)—mostly swelling stockpiles worldwide. Overall, global production capacity—which includes both voluntary and non-voluntary spare capacity—is now greater than actual consumption by more than seven million mbd.

In this framework, the only possibility for oil prices to recover substantially seems to be an effective agreement among oil producers to cut production. Such a hypothesis gained momentum by the end of January, and contributed to a mini-rally of oil prices. However, a formal agreement to cut production and—above all—the execution of such an agreement by the countries that sign up to it, is far more difficult than it may appear.

This brief offers an initial analysis of the forces at work in the world of oil, to be followed by a more extensive analysis later in 2016.

[i] Maugeri, Leonardo. "Oil: The Next Revolution." Discussion Paper 2012-10. Belfer Center for Science and International Affairs, Harvard Kennedy School, 2012.

[ii] Ibid.