Understanding recent oil price swings

Crude oil prices fell from $52.65 bbl. on April 17 to $45.52 on May 4 before bouncing back a day later to close over $46. That’s a 13.6% decline at a time when energy demand is often soft as the world transitions from winter to summer. However, history suggests that U.S. oil demand should be rising as refineries complete their turnarounds and crank up gasoline output for the upcoming summer driving season. So what happened?

First, gasoline inventories are rising and weekly consumption has fallen, which fits with government statistics showing weak consumer spending. A drop in gas consumption can’t explain last Thursday’s 7% decline in oil futures. A variety of other explanations have been floated, such as oil prices falling to where they should be based on fundamentals and inventories, or maybe OPEC failing to cut as much production as it said it would. Perhaps oil prices fell through technical price support levels causing hedge funds that hold large commodity futures positions to sell?

We could offer more explanations, but the message hidden in these disparate theories is that no one truly knows why oil prices fell. However, over 40 years in this industry and the investment business tells me that the market often signals future trends that only become clear later. Could there be a more sinister explanation for why oil prices fell?

One such sinister explanation can be drawn from a comment made by Saudi Arabia’s Deputy Crown Prince Mohammad bin Salman early last week. He said that for the first quarter, the country’s economy was driven more by non-oil businesses than crude oil income.

This might be a temporary phenomenon, but relative to the four quarters of 2016, crude oil prices were higher this quarter, which more than compensated for any reduction in oil exports. The prince is the architect of Vision 2030, which is designed to shift the Saudi economy away from its high dependence on oil. Does the first quarter indicate that the economic transition is happening faster than expected? If so, could this mean that Saudi Arabia is rapidly becoming better positioned to be less dependent on high oil prices? That doesn’t mean they won’t work to get prices higher, but maybe forecasts suggesting that global oil prices will rise to $70 or better next year are wrong. Maybe $60 bbl. might be a better target.

Where does this leave the offshore business? A $60-bbl. oil price in 2018 doesn’t necessarily condemn that sector to purgatory. We are seeing early signs of recovery as oil companies figure out how to operate at lower break even prices that deliver positive investment returns. Never forget that making money is what the oil companies are all about. Once they put their mind to cutting costs — maybe by using more technology or becoming more efficient — they will return to exploring and developing offshore, the last great frontier for the new, large fields needed to meet long-term demand.

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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