This is the first of a three part series discussing the recent past and future of oil prices and the reasons why prices are where they are. April was an interesting time for the crude oil market. From late March until the latter half of April oil prices were above $50 a barrel and oil bulls became excited by the idea that a supply cut led by OPEC and Saudi Arabia would soon tighten balances and lead to increased prices. This has not come to pass and here is why I am doubtful that change in the near future.
People generally overstate how much power OPEC actually has. This true on several levels but right now I am simply stating that OPEC does not wield the same level of control over oil markets that it once did. The U.S. is currently the third largest oil producing nation in the world and its share is growing. Some estimates state the United States will overtake Saudi Arabia to be the world’s number two oil producer by the end of the decade.
Any increase in the price of crude oil is simply going to send more people into the oil business. While there is an upper limit to how many barrels of oil U.S. shale can put on the market that limit moves up with the price of oil. Therefore any increase which an OPEC led coalition manages to achieve will have the effect of further reducing their market share in the future. This is a long term issue however and there is another block in the path of any short term rise in oil prices.
Global refined product stocks are near all time highs and this supply glut will have to be absorbed by the market before production decreases have a tangible effect. Bulls may be of the opinion that the OPEC led coalition can enact supply cuts that will drive prices up. However, this relies upon the assumption that production cuts (and assumes the agreed upon cuts are being faithfully carried out by nations whose best interests are better served by continuing to pump out oil) are irreplaceable.
Oil supplies from OPEC and Russia can be replaced by barrels pumped out of the United States, Canada, the North Sea, Latin America, and Africa. This is already happening and the degree to which it can continue is the key to determining where market balance will be achieved. As long as oil tankers in the Atlantic Basin are able to fill their holds with inexpensive oil and cheaply ship that oil to Asian markets cuts in oil production will not move oil prices. While current market supplies are of course not inexhaustible neither is the patience of oil producers.
If production cuts can be established as effective they must be maintained to remain effective. This relies on Russia, Saudi Arabia, Iran, and Iraq all getting along and maintaining a position which is in the short term detrimental to each of them. Further it relies upon each party believing that the others are doing as they have promised rather than acting in their own self interests (history has consistently shown nation states always do what is in their own best interests).
The idea that supranational organizations can force individual nation states to act against their own best interests has never been demonstrated long term. OPEC may be able to rein in supply and raise prices for a little while as it did in 2008. This is not an effective long term strategy however, as all this accomplished was creating new producers by enabling oil shale and oil sands producers to enter the market at these inflated rates which led to the current market glut.
