Crude oil prices have been on a roller coaster ride. Double-digit rallies and declines of 10-20 percent within a single month seem more the norm than exception. Crude oil is a global commodity, subject to global forces of supply and demand. But increasingly, the world has been focusing its attention on a renewed driver of this market — the United States.
On June 21, West Texas Intermediate crude oil ended a near month-long decline of more than 17 percent at $42.53/barrel, its lowest closing price since August 2016. It also marked a near 22 percent fall from its 2017 high, set in February. On June 22, it began an 8-day rally that increased prices a hefty 10.7 percent. WTI is the benchmark grade of crude oil produced in the U.S. and serves as one of three main pricing barometers of the global petroleum industry, alongside North Sea Brent crude and Dubai crude.
What has been the source of this ongoing chaos in oil prices, and how did it begin? Look to the massive global surplus of crude oil inventories, and specifically, the re-emergence of the U.S. crude oil industry.
In October 2014, Organization of the Petroleum Exporting Countries, or OPEC, embarked on an initiative to increase crude oil production, thereby driving down prices. OPEC is a 14-nation cartel that accounts for nearly 44 percent of the world’s total oil production. Two-thirds of its production is in the Middle East. Led by its de facto leader, Saudi Arabia, the goal was to cripple their competition, primarily a surging U.S. oil production industry, as ultra-low prices made most oil wells unprofitable. In its attempt to regain market share of global crude production, OPEC sent oil prices plummeting. As the world’s surplus of crude oil soared, prices fell from more than $100/barrel in 2014 to under $30/barrel in January 2016.
OPEC’s strategy decimated the U.S. oil producing industry. The number of active U.S. oil rigs fell from an all-time high of 1,609 in October 2014 to only 316 in May 2016, its lowest level since the 1940s. For so many member nations within OPEC, crude oil is a key element of their national economy. The free-falling prices devastated their economic growth and budgets. As a result, on January 1, OPEC and 11 other non-OPEC nations led by Russia, agreed to a six-month production cut in an attempt to raise crude oil prices. The cut, OPEC’s first in eight years, reduced production by 1.8 million barrels/day, representing about 2 percent of daily global production.
Despite OPEC’s production cut, recently extended through March 2018, the price of crude oil has failed to significantly rise. Prices are lower today than when the cut was announced. So why haven’t prices risen? Global demand for crude oil remains strong and is expected to continue into the 2nd half of 2017. According to the International Energy Agency, demand should reach a record high in the first quarter of 2018. However, global supply, already at historic levels, is expected to grow at an even faster pace. Next year, crude oil production outside of OPEC is expected to double from its 2017 levels. And this leads us to the U.S. crude oil industry.
Over the past year, U.S. crude oil production has been a juggernaut. The number of active U.S. oil rigs has more than doubled, rising from 316 to 756, since May 2016. The latest government report shows U.S. crude production at 9.25 million barrels/day. Even with a recent pullback, production remains near the highs of August 2015 and is expected to push toward a 48-year high in 2018. In April, U.S. crude surplus reached 535.3 million barrels, the highest level in recorded history, and remains at elevated levels.
OPEC realizes other nations, most notably the U.S., have proven more than capable and willing to pick up excess slack from its production cut. Gone are the days when its decisions could dictate the price of crude oil markets with near impunity. Recent advancements in technology and efficiency have allowed U.S. producers to remain profitable with prices in the $30-$40/barrel range. At some point, the oil cartel must realize its production cuts to raise prices are self-defeating. Higher prices allow once abandoned oil wells to now become profitable and invite further global production. Control over crude oil prices is increasingly being pulled away from their hands. In the end, OPEC may simply find itself along for the ride.