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The Price of Crude Oil is Rising: Supply Constraints Likely to Emerge

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Crude oil has been on a tear since the beginning of 2019. Like most assets, crude oil was sold during the last quarter of 2018, when a fit of furious liquidation hit just about every market on earth. That trend has reversed, with WTI up around 40% so far in 2019, and Brent up more than 30%.

Unlike gains in global equities, rising oil prices are starting to hurt consumers and businesses. People have to pay for products which are refined from crude oil, which puts pressure on just about everyone in the economy.

 

Chart via StockCharts.com

France has seen wild riots which began over taxes on fuel, and producer prices in the US showed a big push up earlier this week. The increase in the US PPI was fed by energy prices, and that might not be such a great thing for business who are facing a shrinking consumer class.

Over the longer term, there is the possibility that crude oil supplies may undergo a structural shift

Many of the world’s biggest oil producers are dealing with social unrest, economic difficulties, or both. US shale oil has acted as a balance for these supply issues, but it may not be as reliable a source of crude oil as many in the oil industry hope.

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The Crude Oil Market is Complex

The vast majority of nations either consume or produce crude oil. Over the last decade that dynamic has shifted with the introduction of US shale oil into the global energy mix. Shale oil recovery has been controversial, but it has added a huge amount of supply to the crude oil market.

From the perspective of nations like Saudi Arabia and Russia, US shale oil has been a real problem. US shale oil producers have overtaken both nations. Today the US is leading the world in oil production, which would’ve been hard to imagine 15 years ago.

Many of the OPEC member nations need to maintain oil prices at a given level for their national budgets, which is one of the reasons why they coordinate production to influence the global oil price. While Russia isn’t a member of OPEC, they have been working with the cartel to boost petroleum prices.

OPEC+ Cuts

As crude oil prices were cratering in late 2018, OPEC was organizing production cuts to boost the price of oil. Those cuts are starting to hit the global crude oil price, and are probably a big part of why both WTI and Brent have recovered so quickly this year.

Chart via StockCharts.com

OPEC+ (the ‘+’ stands for the OPEC members +10 more major oil-producing nations, Russia, Mexico, and Kazakhstan being the most important) has decided to continue with the production cuts, despite the rise in prices. Many of its members have been suffering because of lower crude oil prices, and they don’t seem to be in any hurry to flood the market with more product.

The Saudi Situation

Whenever OPEC starts cutting production, there are always questions about which countries are actually following the cartel’s instructions. This time around it looks like Saudi Arabia is being honest, and has removed a substantial amount of oil from the global marketplace.

The kingdom needs to pump its national revenues up, as it has extensive social infrastructure that is supported almost exclusively by selling crude oil. Lower oil prices mean less money to spend of pacifying its population, and arming itself so it can continue to be the dominant military force in the Arabian Peninsula.

Unless there is a major crude oil price spike, it is unlikely that Saudi Arabia would push OPEC+ to boost production. Anyone in the oil business knows that US shale producers won’t be able to sustain production at current levels, so waiting for US shale to crumble makes a lot of sense.

Venezuela is a Basket Case

Venezuela has been hit with two major problems. While the South American nation has arguably the largest reserves of oil in the world, its production of crude oil has been dropping. Add to that the recent US sanctions, and it is easy to see why the oil market is looking tighter all the time.

Chart via Wikipedia.com

President Maduro’s predecessor Hugo Chavez started in on a program of nationalization in Venezuela, that has destroyed the nation’s ability to support itself. Unlike other crude oil deposits, Venezuela’s Orinoco belt hosts heavy, sour crude oil. Mining and refining this kind of deposit takes a lot of know-how, which means that foreign firms have to be there to do the work.

Given the state of Venezuela’s finances, and their ‘respect’ for private ownership, there probably isn’t going to be a surge in production anytime soon. If the political situation in Venezuela continues to deteriorate, the specter of a total collapse in the nation’s crude oil exports may become real.

Libya Looks Terrible

Until NATO intervention removed Gaddafi’s regime from power, Libya was a steady producer of oil, primarily for the European market.

Chart via ino.com

Since the invasion, Libyan oil production has been hit-or-miss, as the nation hasn’t been able to recover its political footing. Now, there could be another major military event led by Khalifa Haftar, and his Libyan National Army (LNA).

At this point Field Marshall Haftar and the LNA control most of Libya and are making a push to take Tripoli. Haftar doesn’t have much support from the international community, with the exception of Russia, France, and the UAE.

The end result of all this is a big unknown for the oil market, but it would be unlikely that Haftar would be allowed to usurp power from the UN-backed government in Tripoli without some heavy sanctions from the US, UK, and EU on Libyan crude oil exports. One way or the other, Libyan crude exports are far more likely to decline than rise, at least for the foreseeable future.

The Algerian Wild Card

Algeria doesn’t make the front pages often, but right now a big shift is underway in the North African nation. Former Algerian President Abdelaziz Bouteflika was forcefully removed from power earlier this month, and there is little information about what may come next. Bouteflika had been in power since 1999.

There have been massive demonstrations in Algeria for months, even though they were completely illegal. Now the protesters see Bouteflika’s removal as an opportunity to take a stand for increased human rights, which may not be what the Algerian power structure had in mind.

It is impossible to say what will happen next, but the possibility of a supply disruption from the nation is very real. Late last month the IEA stated that oil production in Algeria hadn’t been impacted by the political upheaval, but that could change at any time now that there is a new political process forming.

Demand Growth is Concentrated, but Steady

The most recent IEA report sees demand for oil rising over the next two years, albeit at a slower pace. The agency thinks that slowing economic growth in China may dent demand for crude oil dipping by 30,000 barrels per day over the rest of the year, leaving demand at 1.21 million barrels per day for the remainder of 2019.

One thing that could cause a serious drop on the demand side of the global oil market is a slowdown in Asian growth, as the majority of additional demand is being driven by growth in China, India, or some other part of Asia.

Chinese growth figures have been revised down in recent months, but many economic indicators give a muddled view of what is actually going on in the world’s second-largest economy. As it stands today, the demand for oil is still growing. A tighter crude oil market will likely keep a floor under prices, or even drive them up further.

Crude Oil Doesn’t Paint a Pretty Picture for Global Consumers

It is no secret that the Northern Hemisphere tends to use more crude oil in the warmer months. This year consumers will be facing higher gas prices, and the potential of price spikes if there is a sudden supply-side disruption that takes a substantial amount of supply off of the global crude oil market.

In countries that use a lot of oil for overland transportation, companies will be looking at shrinking margins if current crude oil price trends continue. In the near term, big oil producers like Saudi Arabia have the ability to raise production and keep the crude oil price at reasonable levels. Over the longer term, the US shale oil revolution may create an extremely difficult situation.

The major problem with shale oil, aside from the lack of profits, is that shale oil operations tend to produce most of their oil up-front. The decline rate from shale oil wells is extremely steep, which means that US shale oil could leave the global oil mix as quickly as it came.

Losing the world’s largest producer of crude oil over the course of a decade isn’t something that is being used in future price projections for oil. For the moment, it would appear that global consumers will have access to plentiful oil, though the prices they pay may be on the rise.

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Nicholas Say grew up in Ann Arbor, Michigan with a father that would read him the Wall St. Journal along side of other bed-time fare. He has traveled extensively, and been lucky enough to study a changing global economy in person. Nicholas spent many years in the Southern Cone of South America, sometimes in the middle of the countryside where livestock starts its journey to all points of the globe. Today he is thoroughly bemused with the stance that Central Banks have taken in the wake of the 2008 meltdown. There is no telling what will come out of the global financial system next, but he is glad that he lives somewhere that gold can be bought and sold readily! nick@moneycheck.com


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1 Comment

  1. Avatar

    Thank you for share it with us ! Exactly was I was looking for and needing to understand about the growth oil prices.

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