Higher Oil Prices?

Higher Oil Prices?

April 13, 2016
Higher Oil Prices?
On January 11, 2016, the price of Brent crude oil, the
market, and hence higher, more stable prices, remains
reference grade on the world oil market, fell to $28.82 per
questionable.
barrel, a decline of over 45% in about three months. On
April 12, 2016, the price of Brent had recovered to $44.68
First, several key nations, including OPEC members Iran
per barrel, and some voices in the oil industry began
and Libya, have indicated that they will not attend the
suggesting that the long period of low, and volatile, oil
meeting, or agree to a production freeze. These two oil
prices, which began in June of 2014, might be coming to an
exporters are important because the target production freeze
end.
date of January 2016 is unfavorable for them. If they
endorsed it they would insure for themselves low market
Figure 1. Spot Price of Brent Crude Oil, 2010-2016
share and revenues generated by oil, their most important
export. January 2016 was the month oil export sanctions
against Iran were lifted. At the time, the Iranians predicted
that within six months they would expand their oil exports
by some 500 thousand barrels per day, and within a year
they would be exporting about a million barrels per day
more than they did under the sanctions regime. If the
Iranians agreed to a production freeze agreement, they
would, in effect, be locking in the effects of sanctions on
their oil exports, even though the sanctions have been lifted.
For Libya, which produced less than 400 thousand barrels
per day in January 2016, less than one third of the total
produced before chaos enveloped the economy in 2011, a
production freeze agreement would ensure that even if the

Source: Energy Information Administration, oil spot price data.
Libyans could resolve their political situation, they would
Graphic by CRS.
be unable to benefit from renewed oil earnings. Other
nations, like Iraq, might also find a freeze objectionable as
their production and exports have recently been increasing.
Although oil prices in excess of $100 per barrel appear
unlikely, prices falling below $30 per barrel again are also
Neither Iran, nor Libya, could conclude that other nations
viewed as unlikely. Because the price of oil is, in effect, a
were sharing the costs of a production freeze. Saudi Arabia
barometer, reflecting the balance between demand and
and others achieved high levels of production in January
supply in the oil market, the question of the level of prices
2016 and are unlikely to have enough excess capacity
becomes one of the potential balancing of demand and
available to expand production. Nor would a production
supply. Over the past two years, supply has chronically
freeze guarantee higher oil prices in the short-term. A
exceeded demand, resulting in increasing storage levels, a
freeze might merely lock in those high levels of production
market supply glut, and lower prices.
and the supply glut that currently exists in the market.
Whether the oil market can achieve balance is partly
However, the current supply glut does have a potential
dependent on the time frame considered, short or long term.
short-term solution. While Saudi Arabia has announced that
In both the short and the long terms, conditions and events
they have no intention of playing the role of a “market
are emerging that might encourage those who hope for
maker,” if they chose to reverse that position unilaterally, or
higher prices, but significant difficulties remain.
with a small group of other large exporters, and decided to
Short-Term
cut production, prices would likely surge within a short
period of time.
An event which has encouraged those who expect higher oil
prices is the meeting of oil producers scheduled for Doha,
Such a strategy would not necessarily be irrational from a
Qatar, beginning on April 17, 2016. The purpose of the
short-term economic perspective. The current supply glut
meeting is to attempt to negotiate a freeze on oil production
has been estimated at about 2 million barrels per day by the
at the January 2016 production level. The meeting is to
International Energy Agency. Saudi Arabia is currently
include Organization of the Petroleum Exporting Countries
producing about 10.0 million barrels per day. If Saudi
(OPEC) nations, as well as major non-OPEC oil producers,
Arabia cut production by 2.5 million barrels per day, oil
Russia, and as an observer, Mexico, among other nations.
markets would quickly tighten as oil in storage was
depleted, and prices would likely rise. All oil exporting
Whether this group of nations can agree to a binding
nations that continued to produce at the same levels would
agreement is questionable, but even if that result is attained,
gain in export revenues. It is even possible that Saudi
short-term balancing of demand and supply on the world oil
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Higher Oil Prices?
Arabia might see a revenue increase. If the price of Saudi
In some sense, long-term oil demand is the wild card in the
oil rose by a greater percentage than the percentage by
market forecast. For the near term, oil demand growth is
which Saudi exports declined, export revenues, the product
forecasted to be weak, reflecting weak economic growth
of price multiplied by quantity, would increase. For
estimates in the emerging economies, China, Europe, and
example, if a 2.5 million barrel per day, or 25%, cut in
the United States. More rapid economic growth could fuel a
exports resulted in a price of at least $60 per barrel, that
more rapid growth in oil demand, erasing the supply glut in
would increase revenues for Saudi Arabia. Even with a cut
the market.
in production, however, Saudi Arabian excess capacity
would likely act as a limiting factor for oil price increases.
Winners and Losers
In the longer term, many other factors would likely play a
A return to higher oil prices, although probably not in
role in determining whether a cut in exports could be
excess of $100 per barrel, would generate both positive and
sustained and beneficial for Saudi Arabia.
negative economic effects both in the United States and in
other nations around the world.
Long-Term
Whether any short-term output freeze or production cut can
In the United States, higher oil prices would quickly result
support higher oil prices long-term is an open question. The
in higher gasoline, diesel, and all other petroleum product
outcome may depend on whether the oil market has
prices, reducing consumer purchasing power, slowing
fundamentally changed as result of the emergence of new
economic growth, and increasing measured inflation.
oil supplies in the United States and, to a lesser extent,
However, higher oil prices would also likely generate a
other parts of the world.
resumption of capital investment in oil production and
development. This would benefit employment and incomes
Over the period 2005-2015, U.S. crude oil production
in both the oil and supporting industries. Capital budgets
increased from about 5 million barrels per day to over 9
have been sharply reduced by the oil industry in 2015 and
million barrels per day. This increase in domestic
2016 and might be expected to recover.
production caused oil imports to decline, and caused other
oil producers to lose their U.S. market share. As these
On the financial side, the state budgets of oil producing
producers, for example, Nigeria, which lost virtually all its
states domestically would gain revenues, improving their
U.S. sales, competed in other markets, excess supply
fiscal positions. In addition, the stock market might also
conditions began to develop and prices weakened. This
gain as energy stocks rose.
result occurred even though the United States had export
restrictions dating back to the 1970s in place. In 2016, those
On the international side, the economies of the oil exporting
restrictions are no longer in place, potentially increasing the
nations would benefit from higher prices. Many oil
influence of U.S. production on world markets.
exporters, for example Russia, Venezuela, and others, earn
a disproportionate share of their total export earnings from
The question of whether the market has fundamentally
oil. The fall in oil prices has caused their national budgets
changed largely depends on how quickly U.S. production
to fall into deficit, causing program cuts, elimination of
responds to higher prices. In 2014, when OPEC decided not
subsidies, withdrawals from their foreign currency stocks,
to attempt to support the price of oil, but to attempt to
and a reduced ability to carry out their foreign policy
defend the market shares of the OPEC nations, some
objectives. These effects have raised the potential for civil
observers believed that due to high production costs, U.S.
unrest, and the inability to resist outside threats.
output would decline quickly as prices fell, first below $80,
and then $50 per barrel. While U.S. production has declined
Not all oil exporting nations are U.S. allies. As a result, in
by about 500 thousand barrels per day since June 2015, it
some cases, the United States has benefited indirectly from
remains over 9 million barrels per day despite the low price
the reduced capability of oil exporters.
environment. The decline in U.S. oil production was neither
as quick, nor as steep, as some observers expected.
Conclusion
Merely the speculation concerning an agreement to support
There is also a belief that U.S. oil production will recover
oil prices has boosted oil prices over the past several weeks.
rapidly due to the incentive of higher prices. This result
If the Doha meetings fail to achieve any agreement, those
depends on the known location of new oil deposits, as well
price increases could easily be reversed. In the longer term,
as the relatively low costs and level of technical complexity
perhaps three to five years, it is likely that prices will attain
of resuming production. If output can expand rapidly as
a higher level if demand growth continues, and if supply
prices rise, the effect of a production freeze agreement, or a
growth is limited by reduced capital budgets for exploration
Saudi Arabian output cut, in supporting prices will not hold
and development of new resources.
in the long-term. Higher prices would cause supply to
increase and excess supply conditions similar to those
Robert Pirog, Specialist in Energy Economics
prevailing in 2014-2016 could re-emerge, causing price to
fall.
IF10388

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Higher Oil Prices?

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