Loren Steffy, UH Energy Scholar
If you want to understand why oil prices keeping rising, consider the 21st and 22nd letters of the alphabet. This current price surge is all about U’s and V’s.
Those are the letters that Greg Hill, the chief operating officer of Hess Corp., one of the biggest independent U.S. oil and gas producers, used to describe the supply and demand situation as oil prices surged toward a three-year high this week. Quite simply, we have U-shaped supply that can’t meet the V-shaped demand.
As a result, West Texas Intermediate crude topped $75 a barrel, which it hasn’t done since the first week of October 2018. And it isn’t likely to stop. Goldman Sachs predicts that Brent crude, the European benchmark which currently trades at almost $80 a barrel, could top $90 by year’s end.
Inventories are falling sharply heading into winter as demand accelerates and OPEC+ continues to add output at a tepid pace. The cartel of oil-producing nations and Russia has held the line on production, adding about 400,000 barrels a day. The group is scheduled to meet Oct. 4 to discuss revising its quotas, but even if OPEC decides to open the taps, it will take a while to make up the current global supply deficit.
“Observable inventory draws are the largest on record,” Goldman analyst Damien Courvalin wrote in a note to clients, as reported by Bloomberg. “This deficit will not be reversed in coming months, in our view, as its scale will overwhelm both the willingness and ability of OPEC+ to ramp up.”
Global demand could hit its pre-pandemic benchmark of 100 million barrels a day by year’s end or the first quarter of next year, and could grow to 102 million barrels after that, Hill told Platt’s Asia-Pacific Petroleum Conference.
Meanwhile, U.S. shale producers, who once could essentially set a price ceiling on oil prices, are largely sitting on the sidelines. Even though they’ve gotten their breakeven drilling costs as low as $35 a barrel in some regions, they’re hamstrung by Wall Street’s demands for fiscal discipline. Rig counts, while inching upward, remain some 60 percent lower than before the pandemic, and market researcher GlobalData predicts U.S. shale production won’t return to pre-COVID levels before 2024.
In years past, banks and private equity funds enamored by the shale boom flooded the industry with cash, which producers poured into boosting oil output. In 2019, they were churning out a record of more than 12 million barrels a day. But the surge helped keep prices low. Companies were drilling more but generating slimmer returns for investors. By early 2020, investors decided enough was enough.
Then came the pandemic, which crushed demand. More than 100 oil and gas companies have filed for bankruptcy since the pandemic took hold. Chastened by the double whammy, U.S. oil companies have been eager to show they’re serious about financial discipline, and they are funneling excess cash into stock buybacks and dividends. So far, even the lure of $75 oil isn’t enough to get them drilling again.
What’s more, major oil companies have expanded their holdings in shale reserves such as the Permian Basin. ConocoPhillips, for example, bought Concho Resources, a major independent shale player, late last year for $13.3 billion, and apparently is now eying Royal Dutch Shell’s Permian assets for another $9.5 billion.
“The majors in particular are holding their capital discipline… Exxon had about 60 rigs going in 2020, now they have close to 10, and the messaging has been that they are going to maintain that level,” Hill said. “I would be very surprised if the discipline did not continue in the shale space.”
At the same time, all the promises of financial restraint haven’t drawn investors back to the sector, which could create longer-term issues if demand continues to rise.
“Pre-Covid, [annual investment] was $650 billion; now it is closer to $300 billion,” Hill said. “My biggest worry is that the industry is substantially underinvesting to meet future supply.”
There’s also a shorter-term worry. Surging prices for oil, natural gas and gasoline are contributing to a troubling advance of inflation. Consumer energy prices have risen 25 percent in the past year, contributing to an overall 5.3 percent rise, the U.S. Labor Department reported. With inflation accelerating at the fastest rate since 2008, economists are increasingly worried that higher prices could put a damper on the economic recovery from the pandemic. Increased costs for energy and other commodities contributed to a higher-than-expected 7.8 percent increase in producer prices for July compared with a year earlier.
In the shorter term, the only hope for relief from the demand crunch would be a decision by OPEC to pump more, which it has been reluctant to do, or some other unlikely event, such as Iranian crude, which has been limited by U.S.-led sanctions, returning to the market.
For much of the 2010s, U.S. shale producers demonstrated an ability to keep a ceiling on global prices. Now, it’s clear that OPEC and Russian have once again reasserted their market dominance over oil prices, leaving us to mind our U’s and V’s. As long as supplies continue to fall short of surging demand, we can expect prices to remain high — and go even higher.
Loren Steffy is a writer-at-large for Texas Monthly, an executive producer for Rational Middle Media and a managing director for 30 Point Strategies, where he heads the 30 Point Press publishing imprint. He is the author of five nonfiction books: “Deconstructed: An Insider’s View of Illegal Immigration and the Building Trades” (with Stan Marek), “The Last Trial of T. Boone Pickens” (with Chrysta Castañeda), “George P. Mitchell: Fracking, Sustainability, and an Unorthodox Quest to Save the Planet, The Man Who Thought Like a Ship,” and “Drowning in Oil: BP and the Reckless Pursuit of of Profit.” His first novel, “The Big Empty,” was published in May 2021.
Steffy is the former business columnist for the Houston Chronicle and previously was the Dallas (and Houston) bureau chief and a senior writer for Bloomberg News. His award-winning writing has been published in newspapers and other publications worldwide. He has a bachelor’s degree in journalism from Texas A&M University.
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