Do Today's Low Oil Prices Presage Another Spike?

20-Jun-2016

Reduced capital investment and cancelled or postponed oil projects, combined with record-low drilling rig activity in the U.S. has many worried that renewed market tightness is inevitable, if not approaching.  My favorite headline is “A 4.5-Million-Barrel Per Day Oil Shortage Looms” referring to insufficient production in 2035. Apparently, “looms” means different things to different people.

Many others have echoed this concern, including industry maven T. Boone Pickens, who in March 2015 predicted that a rebalanced market would see prices of $90-100 by late 2016.  Others are not that bullish, but still expect increased prices within months.


This is actually a very old debate in the industry, with Paul Frankel, the British petroleum economist, arguing that the industry suffered through cycles of over- and underinvestment, while American petroleum economist M. A. Adelman noted that overinvestment was the norm and only various schemes such as the Achnacarry Agreement to restrict output and stabilize prices prevented market volatility.  In the mid-1970s, most academic studies argued that prices would moderate after the 1973/74 increase, and it was only after the 1979 Iranian Revolution sent prices soaring again that many became convinced that prices would not be cyclical but rise inexorably.

The 1986 oil price collapse naturally made many think that lower oil supply and stronger demand would bring prices back up.   Dan Yergin, the most prominent oil industry expert, put forward a typical view in 1985 (before prices declined) that “market realities will again give way to geological realities – the concentration of oil reserves in OPEC and in the Middle East. And that will eventually put the era of surplus behind us.” (by Michael Lynch, Forbes)


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