2014.12.12
Whether you’re troubled or cheered by the recent plunge in oil prices below $60 a barrel, there’s a message embedded in the decline: get used to it. I’m not talking about cheap oil, I’m talking about the 40 percent swing from June, when West Texas Intermediate crude, the U.S. benchmark, was selling for $115 a barrel.
The oil markets have displayed uncharacteristic stability since rebounded from the last precipitous decline amid the 2008 financial crisis. Those days are over, and oil markets are returning to the volatility that has been their hallmark for decades.
For much of the past five years, oil traded in a relatively narrow band around $100 a barrel thanks to a series of remarkable coincidences that kept supply and demand in balance. Those coincidences included rising global demand coming out of the recession offset by sanctions against Iran that restricted its supply of oil, political upheaval that curtailed supplies of crude from Libya and Iraq and the surge in U.S. oil production from hydraulic fracturing.
The overall effect was that supply constricted just enough to keep prices high. Oil observers use the equation that for every 100,000-barrel decline in supply, prices rise by about $1 a barrel.
In the past six months, though, that careful balance has begun to break down. U.S. production continued unabated, even as the global economy slowed and demand waned. Last month, OPEC met to consider what to do, and as usual did nothing. With prices already in free fall, weaker members of the cartel weren’t prepared to slash their own revenue in the name of price discipline. That suited Saudi Arabia just fine. It can afford to grab market share as prices fall, and stare down U.S. producers in the process.
While some U.S. producers have begun curtailing new drilling plans, existing commitments mean that production is likely to continue rising. And some producers refuse to budge. Last month, Harold Hamm, the CEO of Continental Resources, one of the biggest producers in North Dakota’s Bakken Shale, basically bet his company’s future on the notion that the price decline is temporary.
He may be right. If global demand picks up – and some economists are predicting strong growth thanks in part to lower oil prices – crude prices could indeed rebound.
For the moment, though, demand continues to decline slowly around the world because of weak economic activity. Supply continues to expand more rapidly. The U.S., once the biggest buyer of oil, now imports 30 percent less than it did give years ago. That’s why many market watchers looked to the November OPEC meeting for signs that the cartel would pare production to support prices in response.
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