Can crude’s boom-bust cycle be stopped?
The pattern was repeated in 1997, with oil prices falling by more than 60 percent over a period of months. In 2008, the global financial crisis sent markets crashing, and oil prices crashed with them, falling by nearly 73 percent.
Then, beginning in late 2014, unrest in the Middle East failed to persuade traders to ignore the rising glut of crude facing softer demand for oil globally. Prices fell by around 60 percent again, though they have rallied somewhat recently.
The boom-bust cycle in crude oil markets is as old as oil drilling itself, and few believe the pattern will ever end. An assessment by energy analysts at Barclays Capital, an investment bank, estimates that supply-demand imbalances are responsible for 89 percent of historic price swings, including the one the oil and gas industry finds itself in today.
One prominent energy economist thinks there may be a way to end it, but the approach he is pitching isn’t politically feasible. Others are skeptical, insisting that there is simply no way to stop the pattern of industry hiring tens of thousands of workers to fuel an oil boom on the upswing, only to fire them all a few short years later as the crude price plummets.
“Is there any way? No, I don’t think there is,” said John Kingston at Platts, a global commodities price tracking and information hub. “The commodities cycle is a part of the commodities landscape.”
Last Thursday, the U.S. Energy Information Administration (EIA) released the first preliminary estimates of total domestic energy production and consumption for 2014. The agency estimates that total petroleum production, including oil and other liquids, rose by 16 percent last year. Total fossil fuel production, measured in British thermal units, expanded in the United States by about 7.35 percent in 2014, while domestic fossil fuel consumption grew by less than 1 percent, according to EIA statistics.
The contention that no one saw the current oil price drop coming beforehand is false.
Warnings of crude production outpacing consumption were heard at least four years ago. But it wasn’t until the final quarter of 2014 that predictions of a price slump came true, made worse following the Organization of the Petroleum Exporting Countries’ (OPEC) decision to keep the cartel’s oil production at about 30 million barrels per day, nearly a third of the world’s total.
Elliot Wave International (EWI), a Georgia-based investment group that is a firm believer in the power of cyclical crowd behavior, warned of a forthcoming oil and commodities bear market back in 2011. Later, a team of academics warned of a pending oil price collapse in the summer of 2013 at an event held at Rice University.
EWI chief market analyst Steven Hochberg told EnergyWire that unexpected developments merely delayed the start of the fall.
“Sometimes waves develop a degree of complexity, and the commodity bear market that started in 2011 took time before it accelerated lower,” Hochberg said.
EWI believes the oil price crash is a result of a broader pessimistic mood that is beginning to take shape over the markets and the broader global economy. West Texas Intermediate (WTI) crude prices were in the low $40 per barrel range when Hochberg responded to questions. Last week, WTI rose to a bit above $50 a barrel on the basis of fresh geopolitical worries.
“Oil is down 63 percent from the start of the bear trend in 2011, and commodity indexes are down 50 percent over the same period,” Hochberg added. “These trends have become extended, and optimism has now turned to pessimism. But bigger picture, our forecast remains on track.”
A pitch to limit imports
EWI expects a period of instability, with oil prices yo-yoing up and down for a while, before settling at the lower end and staying there for at least a decade. This prediction is almost identical to the one presented before industry representatives two years ago at Rice.
Oil industry boosters are now pressing for the federal government to lift all restrictions on crude oil exports from the United States, hoping that broader market access can help boost prices and possibly save thousands of oil field jobs. Many, including analysts at Wood Mackenzie, doubt that doing so would help lift prices much or have any greater positive impact on business conditions for the U.S. oil and gas industry.
Ed Hirs, an energy economist at the University of Houston, doesn’t think loosening restrictions on oil exports will help improve business conditions, either.
Forget crude exports, he says. Rather, Hirs has been busy lately arguing that the government should instead introduce crude import quotas, keeping domestic drillers insulated from international price swings by giving them a captive market share and restricting foreign oil sales to the United States.
Hirs is lobbying for an Eisenhower era-style import quota on the basis of national security, arguing that oil has “always been a strategic asset.” OPEC in the past used its control of a large part of global oil production to affect prices and as a political weapon, though that’s not the case with the current price collapse.
Likewise, the shale oil boom now affords the United States an opportunity to counteract OPEC, only as a swing demand provider rather than swing oil producer, Hirs says. He admits that an adjustable annual import quota would send domestic oil prices soaring well above international levels, increasing prices at the pump for consumers, as well, but it would protect thousands of well-paid jobs and keep afloat rural communities that host oil and gas operations.
Import restrictions are common for a host of consumer goods, including pharmaceuticals, trucks, alcohol and even cheese in some instances.
“The United States, as a matter of national policy, protects industry,” Hirs said. “Let’s go back and think strategically, like Eisenhower did.”
Kingston doesn’t see any policy prescriptions putting the boom-bust cycle to rest once and for all. He said other schemes to bring greater stability and predictability to commodities markets have all failed.
As an example, he cited the International Tin Agreement, a past arrangement between tin producers and consumers to keep prices stable by artificially moving the market, buying up tin when prices fell too low and dumping the metal into the market if pricing got too hot.
“Eventually, the whole thing collapsed. It was a total disaster,” Kingston said. “All these really smart people thought they would get together and they would do these wonderful things and they would keep the market in check … and that’s the tin market. That’s nothing in size compared to the oil market.”
Hirs accepts that his call for oil import quotas will remain theory for some time and may never see the light of day. He said some lawmakers in Washington, D.C., to whom he floated the idea were receptive, but told him that they could never vote to impose an import quota because it would raise fuel prices for millions of Americans.
There’s even broadening agreement that OPEC’s role in the market has become greatly diminished, both by the shale oil boom in the United States and by relations within OPEC itself.
Data show that nearly all OPEC members have been cheating on their production targets for the past decade, pumping a bit more crude than they initially promised. The only member nation that has kept to its OPEC-sanctioned production targets is Saudi Arabia.
Saudi Arabia is also busy undermining its own capacity to move the global crude markets, likely introducing even more instability in the future.
Jim Krane, a scholar at Rice University’s Baker Institute, highlights the Saudis’ dilemma in a paper he published last week. Krane points out that the kingdom is increasingly using more of its own crude production, with domestic Saudi crude demand expanding by an average 6 percent per year over the prior 10 years. If the trend continues, Krane estimates, that Saudi Arabia’s internal oil consumption will have doubled by 2025, and by then the nation will have become “less willing or able to adjust supply to suit market demands.”
The November OPEC vote in Vienna was contentious, with many members calling for a drop in output to help lift international oil prices. OPEC will have another chance to influence oil prices when it meets again on June 5 to vote on a production target.
EWI’s Hochberg said he isn’t surprised that the oil and gas industry failed to heed earlier warnings that they were pumping too much crude too fast and that it would eventually come back to haunt them. He said it is possible for investors to get ahead of trends and insulate themselves from price shocks, but it is very difficult for companies to buck the broader momentum within their industries, no matter how loudly the warnings are ringing.
“Assume, for example, the odds were high that global economies would enter recession sometime over the next four to eight quarters. Can you imagine Ford, which is in the business of building automobiles, somehow drastically altering its business?” Hochberg said. “They might shut down a plant here or there or make token cutbacks, but no matter what, they are going to build cars.”
EWI argues that oil producers have fallen victim to a broader mood shift, not necessarily from their over-exuberance. Either way, Hochberg says, the industry is in for a much tougher road ahead, reminiscent of the bear market that started with the 1986 oil price fall.
“Mood trends are turning more pessimistic,” he said. “Oil is down over 60 percent; commodities are at new multi-year lows; gold and silver topped over three years ago; U.S. annual GDP growth has not been above 3 percent for nine consecutive years, a record that dates back to the late 1800s. The economy is not stagnating; it’s on the path to outright contraction.”