Crude oil has recently moved to some of its highest pricing levels since last October, when prices touched close to $85 per barrel (“Bbl”) on the Brent trading hub. This pricing surge led to a major late fall correction that slashed prices, at one point, by as much as half.
Currently, West Texas Intermediate (“WTI”) prices are marching upwards again to around $62/Bbl, while internationally-based Brent is closing in on $70/Bbl. Gasoline prices are also marching ever higher towards a national average of around $3 per gallon. This recovery, however, looks a lot like the one experienced late last year, and is tenuous and based, in large part, on geopolitics.
Consider that OPEC’s commitment to additional production cuts toward the end of last year has helped stymie, but not eliminate, the growth in global crude oil inventories. The geopolitical uncertainty in Venezuela and Iran adds a few dollars per barrel to prices on any given day.
On the refined product side, typical spring refinery maintenance and production slate reconfigurations to summer gasoline are pushing prices upward. Refinery challenges in meeting more stringent international marine fuel standards are also reported to be creating a new wrinkle in refinery operations and efficiencies that are also impacting supplies and driving up prices. Midwestern floods are exacerbating these seasonal increases by increasing the complexity of securing ethanol stocks for gasoline blending purposes.
The outlook for future crude oil prices over the summer months is more complicated, particularly in what can be considered the later parts of an increasingly strong, yet very mature (almost 10-year) global economic business cycle.
There are several considerations to keep in mind when thinking about future crude oil prices as markets move from the spring to early summer.
First, global energy markets have shown pretty clearly that they do not like Brent crossing the $80/Bbl threshold, which translates to around $70/Bbl on a WTI basis.
The last time this happened—in early October of last year—the market pulled back quickly and decisively. Prices at this level tend to dampen energy demand and increase crude oil inventories, as they started to do toward the end of 2018.
Equity analysts and investors are wary of the upcoming impacts that currently rising wages and energy prices will have on 2019 corporate earnings.
Lastly, prices at the $80/Bbl level can stimulate accelerated U.S. unconventional drilling activity and more unconventional supplies that ultimately make their way into not just U.S. but global markets. Thus, the closer prices edge to what appears to be their natural “cap” of $80/Bbl ($70Bbl on a WTI basis), the more likely the downward price correction.
Second, the global economy is struggling to find its footing over what has been a relatively long business cycle. China, in particular, has been plagued with slowing economic growth that ripples throughout the rest of Asia. While recent Chinese industrial production numbers have “bounced” out of their contractionary range, this recent industrial output gain was purchased through additional central government spending and borrowing: Once that stimulus stops, the slowing economic trend in the Chinese economy will likely continue.
In addition, Europe is now facing significant economic growth challenges with Germany, the anchor economy of the Eurozone, anticipating less than 1% a year economic growth over the upcoming year. A slow-down in economic growth in both the Eurozone and China will put a lid on significant increases in crude oil prices.
Third, U.S. unconventional energy production is still a global force with which to be reckoned. The U.S. is now the leading crude oil producer in the world at around 11.7 million Bbls per day (“MMBbls/d”) and will likely reach 12 MMBbls/d by the end of 2019. The U.S. is also a major crude oil exporter, putting over 2 MMBbls/d to global markets as well as several million barrels of refined product on any given day.
Higher energy prices only increase the incentives to produce more, particularly as prices reach the $80/Bbl cap. U.S. production represents a form of “just-in-time” inventory that can be quickly and effectively delivered to the market. The fact that there are over 7,000 drilled but uncompleted unconventional wells awaiting commercial operation only underscores the just-in-time nature of this production.
Thus, as we move through the middle part of the year, energy markets are much in the same place they were last year: wanting to move higher, but constrained by important fundamentals, the most significant of which is continued prolific U.S. unconventional production.
There are two primary props holding prices up right now: Saudi commitments to maintaining production cuts and geopolitical unrest in Venezuela.
Both are tenuous, since the Saudis recognize their own precarious position in the Middle East and their need to stay in good graces with the U.S., and the hope that the issues in Venezuela will find a resolution sooner, rather than later, particularly as the humanitarian crisis becomes increasingly precarious.
David Dismukes is a professor and the executive director of the Center for Energy Studies at LSU. He holds a joint academic appointment in the department of environmental sciences where he regularly teaches a course on energy and the environment.