Oil prices have been on a little bit of a rollercoaster in recent weeks. At first, prices were pushed up into the high US$60s and then over US$70 by a weakened US dollar. However, unexpected turbulence in US and global stock markets has since seen prices take a something of a dip. Seemingly overnight, the Dow Jones Industrial Average fell by 1175 points or 4.6% – a drop last seen in 2011 when Standard & Poor’s downgraded the US credit rating.1 The UK’s FTSE 100 and Japan’s Nikkei 225 also saw declines.
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So, what has caused this sudden drop? Is it a sign of impending economic Armageddon? Well, paradoxically, it seems like the problem is good news – specifically, good news about the US economy. On 2 February, the US Labor Department released new data that showed wages had gone up by 2.9% compared to a year earlier, marking the fastest growth in nearly a decade.2 This in turn had been taken as evidence that the low unemployment rate is pushing employers to pay more. Whilst positive for workers, the flipside is that higher pay burdens can mean lower profits for shareholders and, more importantly, increasing wages lead to increasing interest rates – something that the US Federal Reserve has been predicting for years. Torsten Slok, Chief International Economist at Deutsche Bank was quoted by the Washington Post as saying, “The Fed has been predicting inflation and interest rates would go up since 2013 – it felt like a boy-who-cried-wolf situation, but now it’s finally happening.”3 In response to the news, shareholders dumped stocks and moved the money into bonds, which typically benefit from increased interest rates. Erin Gibbs, Portfolio Manager for S&P Global Market Intelligence, was quoted as saying, “This isn’t a collapse of the economy. This isn’t a concern that markets aren’t going to do well, this is concern that the economy is actually doing much better than expected and so we need to re-evaluate.”4 Risky as it is to make predictions, the general agreement seems to be that the trend is temporary and that market fundamentals will see oil prices continue to rise.
Speaking of which: US oil production is booming once again, returning to a peak last seen 47 years ago, as shale producers rush to make the most of the highest prices seen in several years. Figures from November last year show output at 10.4 million bpd, just slightly below the all-time US record set in November 1970. “For decades the only question was how fast are US oil imports going to rise […] Now global oil markets have been put in a bottle and shaken up, and new patterns are emerging,” said Daniel Yergin, Vice-Chairman of IHS Markit.5 Whilst a weakened dollar topped up prices over recent weeks, the bulk of the support behind current prices comes from the production cuts made by OPEC and its allies. If rampant shale production begins to weigh down on prices, it’s likely the group will feel the need to react – whether that will be by making further production cuts or flooding the market is hard to say. The only thing that’s clear is that once again, the industry finds itself in a Mexican-standoff between state-sponsored cartels and free enterprise.
1. ‘US stock plunge sparks global sell-off’ – http://www.bbc.co.uk/news/business-42942921
2. ‘Dow closes down nearly 1,200 points in volatile trading’ – https://www.washingtonpost.com/business/economy/dow-drops-more-than-300-at-opening-extending-fridays-losses/2018/02/05/624f72c6-0a80-11e8-8890-372e2047c935_story.html?utm_term=.9e9f31414995
4. Ibid at 1.
5. ‘Shale powers US oil output to heights of 1970’ – https://www.ft.com/content/7da16504-06af-11e8-9650-9c0ad2d7c5b5