OIL PRICE PLAYING ON A SEE-SAW – IGNORING INVESTMENT IN OIL
There is now a consensus that the 20% oil price rally in August wasn’t sustainable. It was a purely technical issue with the short sellers scrambling to cover their positions. The fundamentals of oil supply and demand remain imbalanced and could remain so until the end of 2016 or probably well into 2017.
Of course, an agreement between the major oil producers to freeze production, will put an immediate stop to this lose-lose situation and raise prices to levels more acceptable to the deficit laden producers. The OPEC September meeting is scheduled, theoretically, to do that, and the Saudi oil minister has alluded as much.
However, Iran is unlikely to go along with a restriction on its production until it reaches its pre-sanctions levels. And the Russians are likely to be wary of any promises after the fiasco last April, when the pre-agreed freeze was cancelled, the last minute, by the Saudis.
On the brighter side, Iran is only 200,000 barrels per day away from its 2011 (pre-sanctions) level, and this may induce it to accept a freeze, esppecially if it means more money for the same number of barrels, and if the other producers are polite and say, please. Russia, in in the middle of a major economic overhaul, which has so far produced very promising results, and raising oil prices would be a welcome addition.
However, failure to achieve a production freeze, means that prices will soon continue to tumble, possibly as far as they did in 2015. This would mean more bankruptcies in the oil industry, as well as more political instability in the producing countries. But worst of all, it would mean further shrinking of the already disappearing capital expenditures on maintenance and upgrading of existing wells, as well as on exploration and development of new oil fields.
There is a long time lag between an increase in oil demand and the ability jack up new production. Hence, by reducing capital expenditure in oil production, the world is leaving the door wide open for a major oil spike in 2018 or 2019, followed a couple of years later, by a more severe repeat of the 2014/15 oil crash.
Economic see-saws (cycles) are a natural state of affairs for economics, and are considered good stabilizers that shave off upward and downward excesses. But when a cycle is too steep going up, it forebodes an opposite steep movement down. Such a “Boom/Bust” cycle is never good – especially in today’s grossly overleveraged world.
Note: Both Saudi and Kuwait (and possibly others) continue to invest in oil, realizing the reality of the coming scenarios. But, that is another topic and will be discussed in a separate article.