Thursday, August 4, 2016
Drilling cutbacks will lead to higher oil prices
Oil markets continue to debate the vagaries of how much crude and refined products are stored in big white tanks and floating carriers. The feeling is that there is too much sloshing around. That’s why the oil price is under siege again, down 10 percent in the past three weeks.
Meanwhile, the untold story is at the front end of the supply chain. The iron equipment that works to put oil into storage vessels is going idle the world over. Every week, an increasing number of drilling rigs are hosting weeds and barnacles. That’s of concern, because fixating on inventories for any product is a narrow thought process. Think of it this way: There are no worries when there is plenty of food in the fridge; but unease about the future sets in when farmers stop planting their crops.
Except for the Middle East, the number of active rigs in every region has retreated to mid-2000 levels. But oil consumption is going the other way; compared to 10 years ago the world burns over 10 million more barrels a day of the vital commodity.
Oil consumption will continue to increase as long as the frontier and emerging markets continue to urbanize and industrialize. Any investment in new oil production that is not made today will show up in less supply in the future. This will result in sufficient high prices in order to signal the market to produce more oil. The problem is the lag times in the price signals actually resulting in more supply. It takes time and effort to get all the steel and iron moving again. Also one must take into account the human capital involved in rounding up all the oil workers and getting them back to work.
These markets are very cyclical and even though prices are down from recent highs one must remember that this is after an almost 100% move in oil off the bottom. Nothing goes straight up.