BRENT CRUDE OIL 2004 – 2005, $/BBL
Volatility is rising in financial markets as President Trump’s trade war continues. Put simply, people are not used to major decisions being announced on a seemingly random basis via social media.
Overall, however, the landscape is becoming clearer. Stock prices are falling, interest rates are rising – and crude oil prices are also collapsing, as the chart shows.
This confirms last month’s warning of a likely major price fall as Brent fell out of its triangle shape. As we noted then:
“The ‘triangle’ is one of the most reliable ‘technical’ indicators in commodity markets.
“It highlights the battle between the bulls and bears, and describes how the range is narrowing – until one side ‘wins’ and the other side gives up. At which point, prices usually start to move a long way.
“It has certainly proved a good guide to oil markets in recent years.”
OIL PRICES CAN POTENTIALLY FALL A LONG WAY
The Oil Barrel Costs the Same as 20 Years Ago
The combination of higher OPEC+ oil output and the likely impact of the US trade war on oil demand has sent crude prices to the same level as 2005
The issue, of course, is Hyman Minsky’s famous ‘Stability Paradox‘, first referenced here when highlighting the risk of a financial crisis in 2008:
“His insight was that a long period of stability, such as that experienced over the past decade, eventually leads to major instability.
“This is because investors forget that higher reward equals higher risk. Instead, they believe that a new paradigm has developed, where high leverage and ‘balance sheet efficiency’ should be the norm. They therefore take on high levels of debt, in order to finance ever more speculative investments.
“Eventually, however, a ‘Minsky moment’ occurs. Earnings from the new investments prove too low to pay the interest due on the debt. Confidence in the ‘new paradigm’ disappears and, with it, market liquidity. Investors find themselves unable to sell the under-performing asset, and suddenly realise they have over-paid. In turn, this prompts a rush for the exits. Prices then begin to drop quite sharply, as ‘distress sales’ take place.”
As the Bloomberg chart shows, oil prices have been ‘stable’ for the past three years. Most traders have therefore assumed they would never fall below $70/bbl. But in reality, oil market instability is never far away.
OIL MARKETS ARE OVER-SUPPLIED IN THE SHORT AND LONG-TERM
In the top two areas in which your firm is active: What West Texas intermediate (WTI) oil price does your firm need to cover operating expenses for existing wells?
Today, oil markets face their traditional challenge: the period of high prices has encouraged more supply.
- OPEC+ chose to ‘balance’ the oil market by cutting output by 6mbd
- But this simply led Kazakhstan, Iraq and UAE to cheat on their quota
- It also meant US output has been hitting record highs of over 13mbd
Inevitably, therefore, Saudi Arabia has to respond – or risk losing permanent market share. And so a new oil price war now seems to be underway.
The issue, as the Dallas Federal Reserve chart shows is that Large US producers only need a price of $31/bbl to operate. Smaller US producers, however, need a price of $44/bbl.
So the US can continue to pump for some time until prices hit these levels. But OPEC+ can assume that US production will start to decline as prices reduce to $50/bbl or lower.
The reason is that many producers can’t profitably replace production at that price. New wells need an average price of $61/bbl for Large companies, and $66/bbl for smaller producers.
FOSSIL FUEL PRODUCERS FACE A DOUBLE CHALLENGE
Global investment in clean energy and fossil fuels, 2015-2024
OPEC+ and US producers also face a completely new challenge from renewables.
In the past, producers could assume that supply and demand would eventually come back into balance.
But today, it is very unlikely that the world needs all the new production brought online in OPEC+, the US, Brazil, Guyana and Norway.
The reason is that investment in renewable energy is surging, as the chart from the Oxford Institute for Energy Studies confirms:
“The global energy landscape is undergoing a major transformation, upending decades of economic thinking built around resource scarcity”.
Renewable energy has two great advantages for the consumer:
- It means they can’t be blackmailed by oil producers who either refuse to supply, or increase prices arbitrarily
- By contrast, renewable energy costs fall, in line with the famous Boston Experience Curve, as production increases
As Oxford notes:
“Once renewable infrastructure is constructed, the ‘fuel’ itself arrives freely and perpetually. This transforms energy from an extractive industry into essentially a one-time manufacturing challenge followed by decades of near-zero-cost harvesting.”
This is good news for the global economy and energy consumers. But it involves a messy and painful transition for energy consumers and producers.
The Energy Transition is well underway with California now able to run for weeks at a time on 100% renewables. But at the same time, President Trump is hoping to turn back the clock with his ‘drill, baby, drill’ policy.
Oil price volatility is therefore set to add to the general volatility Trump has created in the wider economy and financial markets.