Chart of the week – new ructions in crude oil market

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Having stablised since the start of 2017, oil prices have dropped by over 10% in the week ending 17 March 2017, breaking through the level of USD 50 per barrel.

Ultimately, the explanation for this fall in the price of crude oil is to be found in disruptive technology and the technical progress that has driven the shale revolution, transforming the US from an importer of gas and oil to an exporter. The US is now the largest producer of petroleum and natural gas hydrocarbons in the world, supplying 13% of the world’s oil and 21% of its gas.

Shale production has transformed the global energy business and has numerous implications. Those countries/regions previously dependent on revenues from oil exports are likely to suffer from the changes underway. The net economic effect is a redistribution of wealth away from producers in favour of consumers. Oil prices would appear to have embarked on a long period of instability due to a structural change in the energy business, where in contrast to the previous paradigm, growth of supply exceeds that of demand.

Exhibit 1: Changes in the price of crude oil over the period between 15 April 2014 and 15 March 2017

Source: Bloomberg, BNP Paribas Asset Management, 15 March 2017

Key to Exhibit 1:

1. After a long period of stability (during the three years ending 2014 crude oil prices traded in a corridor between USD 80 – 90/barrel) crude oil prices went into a slump reflecting profound changes, brought about by the advent of shale production, on the energy industry.

Lower prices did not, as expected, eliminate higher-cost producers in the US shale basins. Instead they triggered significant efficiency gains. The number of rigs searching for crude oil in US fields has been rising since May 2016 (see Exhibit 2 below). Lower crude oil prices forced US producers to cut costs, automate and increase overall efficiency. The US has become a world leader in developing horizontal drilling and fracturing techniques.

2. In January 2016, prices of crude oil, depressed by a combination of abundant supply and angst about prospects for the global economy (deflation, fears of an economic crisis in China), traded at twelve-year lows below USD 30 per barrel.

3. In December 2016 the Organisation of Petroleum Exporting Countries (OPEC) and 11 other major producers agree to the first cut in oil production since 2008. Under the deal OPEC members will cut production by 1.2 million barrels/day with non-OPEC members chipping in with a further 600,000 b/d. The cuts in production began on 01/01/17 and last for 6 months.

4. On 8 March 2017 the US Energy Information Administration announced that US crude stocks had climbed for a ninth straight week to a new record. This news triggers a sharp sell-off, sending the price for crude below the level of USD 50 per barrel for the first time in 2017. It would appear that the magnitude of the increase in US shale production, driven by the higher price of crude oil, has exceeded expectations.

5. On 14 March 2017 OPEC published a report that raised concerns Saudi Arabia, the world’s largest oil producer, was not curbing output as agreed. This promoted lead to a statement from Saudi authorities reiterating commitment to “stabilizing the global oil market.”

Exhibit 2: Lower oil prices did not eliminate shale production – the number of rigs searching for crude oil in the US has been rising since May 2016

Source: Bloomberg, BNP Paribas Asset Management, 15 March 2017

Written on 15 March 2017

Andrew C. Craig

Head of Financial Market Analysis & Publications

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