Is the oil bust over?

A Houston Chronicle business columnist wrote an article Monday declaring that the current oil bust was over now that Brent oil prices are trading above $60 bbl., the minimum target price suggested by OPEC as a measure of its success in shrinking global oil inventories. The columnist also said that the last thing the industry needs now is another boom.

The problem is that reduced breakeven prices for shale oil projects and growing U.S. oil exports will be factors that will drive a stable oil price environment, which, in the columnist’s mind, should prevent another industry boom.

Oil booms, like those of any business, come from a large dose of optimism. Now, a small dose of optimism has restored a more positive outlook for oil prices, at least for the near term, at exploration and production companies. Importantly, the number of true optimists in C-suites remain few, which will help keep oil prices up but probably not spark a surge in capital spending.

While we may be a long way from another oil boom, ruling out another one may be premature, unless you are willing to name your time frame. This is akin to the advice for forecasters: never give both a price and a date.

Oil busts have always arrived when the reality of the market does not meet people’s expectations. Think about the fall of 2014. At the time, Saudi Arabia pulled its support for OPEC’s price target and spot oil prices had already fallen 31% over the previous five and a half months. The first trading day following that fateful Saudi Arabian announcement, oil prices dropped by 11%, and then by another 30% over the following month and a half. That price performance demonstrates how surprised the market was with the Saudi Arabian decision.

As we approach the third anniversary of Saudi Arabia’s decision, oil prices are soaring on the surprising events in the Middle East, as the ruling family takes more aggressive steps in restructuring its economy and its society, which involves eliminating any potential political opposition. The net result for oil prices is that after several years without a Middle East oil flow disruption risk premium, we now have one. The oil market is now pricing in the potential for the loss of some Middle East east oil (and certainly Venezuelan oil) which would accelerate market tightening. While that premium exists, oil prices are largely reflecting the prospects for the end of the oil bust.

Be aware, however, that if oil demand softens in the face of higher oil prices and U.S. oil shale output grows faster than expected, those conditions could overwhelm concern over the political risk premium, just as the market has ignored it for nearly three years. Although not creating a bust, these conditions could forestall another boom. For now, enjoy the higher oil prices and increased oilfield activity.

About the author

G. Allen Brooks

G. Allen Brooks is a 40-year veteran of the energy and investment industries, serving as an energy securities analyst, an oilfield service company manager, a consultant to energy company managements and a board member of several oilfield service companies. He is the author of the highly regarded energy newsletter “Musings From the Oil Patch” that interprets trends within all sectors of the energy business.

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