The World Oil Market: Towards Persistent yet Small-scale Volatility?
By: Iakov Frizis, Economist, CASE
Last week, oil prices fell by 10% as news regarding stronger-than-expected North American production echoed across international markets. This news only added to the recent uptick in oil price volatility.
Between September 2016 and January 2017, the international oil market experienced a brief period of reduced volatility. Expectations of output cuts by OPEC countries (and Russia) led to reduced expected supply of crude. A future outlook of higher prices coupled with relatively higher demand (as the world economy recovers from a period of sluggish growth) pushed the price of crude above $50 per barrel and flattened the market’s contango structure. However, that proved to be a short-lived equilibrium. Increasing doubts to whether or not OPEC will be able to sufficiently curb world output, given higher than expected US-based production, motivated an upward revision of future output expectations.
The rise of the US as the world’s top oil producing country, according to estimates of existing fields and future discoveries, coupled with the country’s positioning as the greatest oil consumer and the sector’s output transparency (in terms of data), lends an outsized influence over the market. This is showcased by the ripple effects caused on the world oil market by the US Information Administration’s upward revision of output expectations for the near future — an increase of 300,000 barrels a day (b/d) for 2017 (reaching a total of 9.2 m b/d), followed by a further increase of 500,000 b/d in 2018.
That is not to say that the US shale sector has the capacity to set the price of crude by determining world supply (given current demand) as the Saudi Arabia used to do, in the period following the demise of the 7 sisters. Although, by assuming a leading role in determining the upper cap of the price of crude, it limits OPEC’s price setting capacity to only determining the lower cap (through OPEC’s capacity to flood the market). This outcome is the result of the recent price wars between the US shale producers and OPEC. Consolidation in the US shale industry led to significant efficiency gains, resulting in a current output level that is less responsive to price changes. This divorces the commodity from OPEC’s monopolistic control, introducing a new normal of heightened price volatility.
However, extreme uncertainty involving the oil price surging up to $100 per barrel and then plummeting down to $50 per barrel is not in the cards for the near future. Saudi Arabia appears determined enough to protect the OPEC agreement, if not extend it, in anticipation of ARAMCO’s IPO. Moreover, demand for oil is not to peak before mid-2020s to late-2030s, according to estimates of Royal Dutch and Statoil (the International Energy Agency sets peak oil in 2040s). This suggests that the international oil market is moving towards a less constricted structure of supply determination, meaning small-scale price volatility instead of wild swings.
