Slow Expansion, Steady Prices

Professor of Economics
Slow Expansion, Steady PricesSlow Expansion, Steady Prices

The Federal Reserve Bank of Dallas has released its Energy Update report for July, predicting a further fall in West Texas Intermediate and natural gas prices.

Despite the price fall, employment remains strong in Texas oil industry that has been on the path to recovery since May 2016.

Falling WTI prices have only slowed expansion in this sector, but nothing more. The refinery utilization ratio, rising from 93.4% in May 2017 to 93.7% in June, substantiates this conclusion.

WTI price in July settled at an average of $45.51 per barrel, with Brent at $47.1 per barrel. Federal Reserve Bank of Dallas does not foresee any immediate rise in prices, considering oil and natural gas to remain stable for the rest of 2017.

Part of this is because the global consumption of oil is lagging behind supply. In the second quarter of 2017, global crude Global supplies slowed down in 2017 following some OPEC countries’ decision to reduce production. In June, OPEC’s crude oil production reached 32.6 million barrels per day, demonstrating an increase in output after a sharp fall in late 2016 and early 2017.

OPEC crude oil production is expected to stabilize, with some frictions, at around 33 million barrels per day in the second half of 2017 and early 2018, pushing global oil supply to exceed demand.

At the same time, OECD’s commercial oil inventories have been increasing since 2014, reaching 3,005 million barrels in June 2017. These inventories will hamper any sudden increase in oil prices by giving developed economies the option to use reserves instead of placing orders for oil at rising prices.

It seems that brakes are in place and oil market is destined to remain in equilibrium through 2018.

Some might interpret this as a depression in oil markets. However, with stability comes reliability and predictability. The expansion now continues, as investors reach to invest in oilfields where production is justifiable at current prices, at the equilibrium rate of return for their investment.

No one expects high returns and there is no surplus of capital anymore. The expansion is slow, but the oil industry is expanding and not shrinking.

For example, the number of oil rigs in the United States has been increasing since mid 2016, reaching 756 rigs this summer.  Texas alone is pumping 3.34 million barrels per day and oil activities continue across OPEC and non-OPEC oil producers.

There is no surprise to see that business activity in this sector, particularly in the traditional section, has been robust. It is true that shale oilfields have slowed down and exploration in some have stopped. However, it is also true that investors have a somewhat reliable investment horizon in oil production.

Now they can dedicate fresh capital to experimenting new ideas to lower production costs.  That promises improving profit margins with less destabilizing effects compared to increased volatility in oil markets. Low oil prices are not as horrible as some might think. For one, they keep the market stable and stability is a good thing.

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