After several years of relative price stability, the oil markets sailed into a perfect storm in the second half of 2014. High growth in supplies met with low growth in demand. Global oil supply was supported by production from U.S. tight oil plays, which exceeded 4 million barrels per day in 2014 — barrels that were not being produced in any large volumes just five years ago. In addition, Libyan supplies returned to the market more quickly than anticipated, despite continued unrest within the country, adding yet more barrels to OPEC’s 30+ million barrels per day of output. And then negative data on economic growth from China, Europe and Japan triggered downward revisions to oil demand outlooks. The surplus of supply relative to demand on the world market then triggered a sharp drop in prices. The global benchmark Brent crude oil fell from an average price of $112 per barrel in June to less than $50 at the time of this writing. This 60 percent drop is approaching the severity of 2008’s 70 percent drop. The jolt to the markets is real. And past experience reveals that lower price levels tend to be accompanied by greater price volatility.
The combination of volatile yet low prices presents a challenge for business decision makers. Crude oil producers are examining their portfolios to ensure capital is deployed efficiently and sustainably. Companies are reducing plans for capital spending so as to manage the downturn. The magnitude of each cut is specific to each company’s circumstances, influenced by numerous factors ranging from balance sheet strength to diversity of the production portfolio. Producers will “high-grade” their portfolios to ensure maximum returns. Rigs in the most productive, highest return areas are expected to continue drilling new wells. The industry is seeing a drop in rig activity with a recent Baker Hughes’ survey (Jan. 9) reporting 1,421 oil rigs active in the U.S., down 188 from the October 2014 peak of 1,609. Vertical rigs declined first, followed more recently by horizontal rigs.
U.S. oil production is rising now and is projected to continue growing in 2015 over today’s level. In its latest Short Term Energy Outlook, the U.S. Energy Information Administration projects production rising to 9.3 million barrels per day at West Texas Intermediate (the U.S. benchmark) prices of $62.75 per barrel in 2015 versus 8.6 million barrels per day and $93.82 in 2014. U.S. oil production can continue to increase, albeit at a slower pace, because the best wells deliver good returns on investment even at low price levels.
However, a lower, more volatile price environment poses a threat to the economic success story that tight oil created across the U.S. The jobs and income growth resulting from oil production are critical components of the U.S. recovery from the Great Recession. U.S. Bureau of Labor Statistics data show approximately two hundred thousand new jobs were created in oil and natural gas extraction and support services since the third quarter of 2009. These jobs indirectly create many additional jobs throughout the economy. According to recent research by the Manhattan Institute, a total of ten million jobs are associated with the oil and gas industry in fields as wide-ranging as transportation, construction, education, health care and food services. Consequently, if producers and service companies were to repeat past cutbacks of ten to twenty percent of their workforce, negative spillover effects to other sectors should be expected.
In a more challenging global market environment, it is vital that U.S. businesses do not face an uneven playing field, with regulatory hurdles that put them at a disadvantage to non-U.S. firms. As the only country that bans crude oil exports, U.S. policies hold oil producers captive to a limited domestic market, unable to tap the wider global market of buyers. This puts U.S. producers at a clear disadvantage to non-U.S. producers. It also disadvantages U.S. producers relative to refiners whose products are freely exported worldwide. Consequently, the negative effect of low prices, which hurt oil producers as well as steel and other industries, are magnified by restrictive, outdated trade policies. The nation’s best interest is served by removing barriers to trade, thereby allowing U.S. oil producers access to the world market, as this supports domestic jobs and income growth.
Helen Currie is the Senior Economist for ConocoPhillips Corporation. She manages strategic planning initiatives, oversees the company’s long range plan development, and advises on investment analyses, political risk and scenario planning. Previous roles at ConocoPhillips include Upstream and Downstream business analysis, leadership roles in Commercial risk management across all commodity groups and project management. Dr. Currie also worked with BG Group, leading the Americas Market Analysis research team. She has prior experience in government and academia.
