Oil prices have been showing some significant volatility of late, renewing speculation as to the state of the industry and when we might see a turnaround.
The recent sharp rise from less than $38 per barrel to more than $47 just a few days later caught the attention of many market watchers because it was among the largest jumps in decades (albeit starting from a low ebb). There are some signals that things are changing in the marketplace, and prices may begin to rise in a lasting and meaningful way, but I don’t think we are there quite yet.
First, the bad news for those hoping for higher crude oil prices sooner rather than later. The market is now oversupplied, even though demand is generally solid. Strong production growth in the United States is one reason as technological advances enabled us to tap into shale reserves at a rapid rate over the past few years. As long as supply exceeds demand, there will be downward pressure on prices.
Another negative sign is that data coming out of China continues to indicate that the world’s second-largest economy is definitely slowing, as I’ve noted previously. In addition to decreasing demand for oil among the Chinese, slower growth in China will tend to pull down economic performance in other countries. Although I am not anticipating a major meltdown in China beyond what has already occurred, it is clear that sluggish growth there will affect economies around the globe and, hence, the demand for oil.
Other bad news at present is that part of the recent upswing looks to be based on a misinterpretation (or wishful thinking). A recent report from the Organization of the Petroleum Exporting Countries (OPEC) included language such as “continuing pressure on prices, brought about by higher crude production, coupled with market speculation, remains a cause for concern for OPEC and its Members” and that the Organization “stands ready to talk to all other producers.” This was interpreted by some as a signal that OPEC was set for a policy shift toward curtailing production and pushing up prices. When a few traders started buying on the news and the price started to edge upward, traders who had bet on low future prices also jumped in to cover their positions and the price rose further. However, it looks like the report was much less of a signal than originally imagined, and OPEC insiders have discounted the idea of an imminent policy shift, and July OPEC production was the highest monthly total in recent history.
On the other side of the equation, there are several changing parameters pointing toward higher prices. First, US crude oil production is beginning to fall. The Energy Information Administration (EIA) estimates that crude oil production in June 2015 was 9.3 million barrels per day (b/d), down about 100,000 b/d from May. Also, the EIA has implemented a new survey of companies as part of its estimation process, and the resulting revision for May took off another 100,000 b/d.
The characteristics of the shale wells which have been instrumental in the strong growth in U.S. crude production over the past few years will work to continue and even accelerate the drop in production until prices turn around. Wells in shale plays tend to have steep decline curves, with relatively rapid declines in production during the first few months, then a slower drop. When prices justify drilling, production can quickly rise; when drilling slows, production soon follows (which is the case to nearly the same degree in traditional fields). Lower production will decrease the oversupply over time, removing some of the downward pressure on crude prices.
Moreover, there is no doubt that OPEC members and other major producing nations are feeling the economic pinch of lower prices. For some countries, oil is essentially the only resource, with few other sources of business activity to pick up the slack when crude prices fall. Many nations are running high deficits and rapidly burning through accumulated assets as they fund government operations with drastically lower revenues. Currency problems are also escalating. Many nations rely on exports of oil to obtain foreign currency, and several currencies are down sharply. Pressure is mounting, and at some point restricting production to boost prices is the most likely outcome. Some traders may have been a bit quick on the trigger recently, but not dramatically so.
I continue to see the current low oil price environment as having a decidedly negative (though not catastrophic) effect on the Texas economy. As I have noted in prior columns, this year, we are estimating that Texas will add only about 171,000 jobs (rather than the 284,000 I projected under a higher oil price situation like we had in the fall). I see the pace of growth picking up fairly soon again after that, but a residual effect remains. On average over the next five years, I’m estimating that the Texas economy will grow at a rate about 10% lower than would be the case with prices in the $75 range (with the pattern over the next couple of years being quite different from that found in a higher-price scenario). If prices turn around sooner than expected, my forecast for the Texas economy would certainly be more positive.
There are still some negatives at the moment, but the current low price is not sustainable. Although many pundits are stretching out their predictions of low prices, I see less than a year as the most likely scenario at present. I have said all along that oil prices would turn around when OPEC got tired of losing money, and it looks like they are starting to show a few signs of fatigue.
