Analysis: The ‘New Normal’ For Crude Oil Prices Likely Another Chimera
By Vincent Lauerman
It is widely believed among oil analysts and market commentators that the world oil market is experiencing a ‘new normal.’ As a rule, prices for international benchmark crudes such as North Sea Brent Blend and North American West Texas Intermediate are not expected to rise above $70 to $80 per barrel.
The primary reason for the supposed ‘new normal’ for crude oil prices is the light, tight oil revolution in the U.S. As the price of WTI moves back above $50 per barrel, drilling activity in the Bakken, Eagle Ford and Permian basins is expected to quickly revive, again driving U.S. crude oil production substantially higher.
But based on Black Swan events impacting the world oil market in the past, and the potential for such events in the future, continuing volatility is likely to be the norm instead. There is a great deal of upside potential for crude prices given a wide range of possible geopolitically-inspired disruptions to oil supply.
Relatively low crude oil prices contain the seeds of their own destruction. Most major oil exporting countries are highly dependent on oil revenues for foreign exchange and budgetary purposes. Despite many of them being low cost producers, the price required to balance their external and government accounts tend to be substantially higher than $70 to $80 per barrel.
Numerous Black Swans have impacted the world oil market on both the supply and demand side since OPEC came to dominate the world oil market in the early 1970s. Some of these have driven oil prices substantially higher, while others have driven them into the depths.
On the upside, the 1973-74 Arab oil embargo caused crude oil prices to quadruple from roughly $3 to $12 per barrel in a few short months. The Iranian revolution in 1978-79 drove prices above $40 per barrel at their peak.
In addition, China’s admission to the World Trade Organization in December 2001 and its subsequent positive impact on Chinese and global economic growth contributed to rapidly rising oil consumption and prices for several years. Nymex WTI peaked at an all-time record high of $147 per barrel in July 2008.
On the oil price downside, the Asian financial crisis in 2007-08 and the 2008-09 global financial crisis both negatively impacted oil consumption growth and caused crude oil prices to crater in a matter of months.
The importance of the U.S. light, tight oil revolution, the most recent Black Swan, did not become readily apparent until Saudi Arabia pulled the trigger on another market share war in mid-2014. The impact of rapidly rising U.S. oil production had been masked for several years by a combination of geopolitical and other reasons taking as much as 3.5 million barrels per day offline.
As in the past, geopolitically-inspired disruptions to oil supply have the potential to increase crude oil prices substantially above expected levels, for not just months, but years. Although global oil inventories are currently flush, the world oil market has a razor thin 2.5 million barrels per day of spare production capacity, and most of it is in the politically unstable Middle East.
Relatively modest disruptions to oil supply in Nigeria and Venezuela have already contributed to benchmark light, sweet crude prices rebounding to around $50 per barrel. The potential for most, if not all, of Venezuela’s remaining 2.4 million barrels per day of crude production going offline for an extended period is quite great given increasing civil unrest in the country.
More importantly, oil production in Iraq, and possibly even Saudi Arabia, could come under threat if crude oil prices remain relatively low in the future. Iraqi crude production has been remarkably resilient despite ISIS controlling large swaths of central Iraq over the past two years, and in fact hit a record 4.6 million barrels per day in the first quarter of this year.
Most oil production and resources are found in the Shiite-dominated south and Kurdish-dominated north of Iraq. But rising intra-Shiite rivalry in the south, partly due to a dwindling oil revenue pie, is increasing the possibility of armed conflict in this region.
The ultimate Black Swan for the world oil market would be widespread civil unrest in Saudi Arabia. The current economic path of the Kingdom is unsustainable with relatively low oil prices, skyrocketing domestic oil consumption and a rapidly rising indigenous population. This has prompted Deputy Crown Prince Mohammed bin Salman to adopt Vision 2030 in an effort to decrease Saudi reliance on oil revenues through expansion of the private sector and greater foreign direct investment.
Based on press reports, officials associated with the U.S. national security establishment believe that Deputy Crown Prince’s ambitious economic plan is a last chance gas for Saudi Arabia. “It’s him or it’s ISIS,” according to one of these Saudi experts during the prince’s recent visit to Washington, DC.
Vincent Lauerman is president of Geopolitics Central, a Calgary-based consultancy.