Why Oil Prices Won't Rise Much Further

Over the past month, the price of oil has risen by around 10%, pushing oil prices to their highest level since mid-2015.  This has raised hopes among the world’s leading oil producing countries that this rise would prove to be more sustained than previous increases in the price of oil over the past few years.  For many countries, the 50% decline in the price of oil over the past three years has been a devastating blow for their economies, as very few of the world’s leading oil producing countries have economies that are diversified enough to offset any sharp declines in oil revenues.  This is due to the fact that, between 2011 and 2014, the average price of oil was more than 60% above the level of the last three years, and governments in most oil producing countries based their fiscal policies on the expectation that high oil prices would remain in place. Now, for the first time in recent years, there is some significant upwards pressure on the price of oil.  Nevertheless, the factors that drove down the price of oil in recent years remain in place, and are unlikely to dissipate without major external shocks.

Over the past year, many of the world’s leading oil producing countries have stepped up their efforts to force oil prices upwards.  The most important of these efforts was the agreement among OPEC member states and a number of non-OPEC oil producing countries (most notably Russia) to cut their levels of oil output in order to raise the price of oil.  In the first few months of this deal, it appeared as if it would not last, as a number of the countries that signed the deal were reluctant to adhere to its terms.  However, to the surprise of many, this deal has not only lasted for nearly a year, but it has been extended until March 2018, with additional output cuts agreed upon.  At the same time as this deal has been implemented, global demand for oil has risen together with the acceleration of global economic growth.  Together, the reduction in supply and the increase in demand of the past few months have combined to result in the recent 10% increase in the price of oil.  Nevertheless, while oil producing countries are relieved to see that their efforts have helped to raise oil prices, they know that this increase may prove temporary, as a number of factors continue to weigh heavily on the price of oil.

Of all of the factors that continue to prevent oil prices from rising to even higher levels, none is more important than the increase in oil output from non-traditional sources.  Of these non-traditional sources, none has had a larger impact than the shale oil industry in the United States.  According to a new report from the International Energy Agency (IEA), the United States is now the leading oil producing country in the world and will account for 80% of the increase in the worldwide supply of oil over the next ten years.  In fact, US oil production reached a record 9.65 million barrels per day recently, a 15% increase from the level 18 months ago. 

This increase in US output almost completely offsets the 1.8 million barrels per day reduction in output that was agreed upon by OPEC member states and Russia earlier this year.  Furthermore, the ease of starting and stopping shale oil operations means that US oil producers can quickly react to any increase in the price of oil, bringing new supplies to the market just weeks after prices begin to rise.  Moreover, the shale oil industry has much room for growth, both in the United States and in a number of other countries such as Mexico and Argentina.

Should the price of oil maintain its recent gains, or even rise further due to higher-than-expected demand or disruptions to oil output, it is all-but-certain that the United States and some other countries will boost their output accordingly.  Furthermore, while the demand for oil has exceeded expectations in recent months, the longer-term outlook for oil demand remains relatively weak.  With long-term demand threatened, many countries are planning to increase their output in order to ensure that they take advantage of their oil reserves before alternative sources of energy become more prevalent.  One example of this is Brazil, where the government has ordered the acceleration of the development of the country’s deepwater oil reserves in order to benefit from them before it is too late. 

Overall, it is clear that, without major shocks, oil prices are unlikely to rise too high for the foreseeable future.  In fact, it appears that only major disruptions to oil output will have the ability to significantly raise oil prices in the years ahead.  Of these potential disruptions, the one that would have the greatest impact on the price of oil is a potential conflict between two or more of the Middle East’s leading oil producing countries, such as Saudi Arabia and Iran.  As such a conflict would have a devastating impact on many of the world’s leading oil producing countries, it is clear that there are more tough times ahead for the world’s oil producers.