Global crude oil supply has suffered significant disruption in recent weeks from sabotage in Nigeria, fires in Canada, and political failure in Venezuela, supporting a rise in prices to nearly $50 a barrel. By some accounts the supply disruptions have reduced the previous surplus and will allow a rebalancing of global inventory if supply remains constrained.
Global Crude Inventory Now Appears StableFor decades the market has relied upon OPEC to increase production after a supply-shock to keep crude consumers well-supplied. The OPEC Thanksgiving 2014 decision not to restrict, and the Saudi Arabian decision to increase, production has allowed crude oil inventory to grow with a parallel decline in price. The decision to delay or cancel capital intensive exploration and production projects, reduced North American unconventional activity, and demand growth have recently stabilized inventory levels.
Is Spare Production Available To Meet Demand If More Supply Disrupted?
Most analysts do not expect OPEC to reduce production at its June 2, 2016 meeting. Not cutting production will likely slow other producers from bring production back to market as more inventory is worked through.
Some oil analysts believe the OPEC decision to continue producing at current high level reduces its ability to rapidly increase production should another significant supply disruption occur. If true, then an additional future disruption could introduce a sudden, unexpected price shock.
Historic Relationship Between Oil Supply Shocks And Prices
The Center for Financial Studies (CFS) published “Forty Years of Oil Price Fluctuations: Why the Price of Oil May Still Surprise Us” in January 2016. This excellent, peer reviewed paper notes that past physical crude supply disruptions have affected a small percentage of global supply but created proportionately higher long-term effects due to changed consumer expectation as to future prices. U.S. consumers, for example, “typically form expectations about the … price of gasoline according to a simple no-change model such that the nominal gasoline price is expected to grow at the rate of inflation.”
Low Gasoline Prices Induce Sticky Demand Growth
Globally consumers have reacted to the rapid decline in oil price since 2015 by buying and driving more and heavier passenger vehicles, increasing gasoline demand beyond expectations. Because the decision to buy and drive a passenger vehicle involves significant consumer investment, a subsequent significant increase in the price of fuel does not immediately reduce consumption.
Who Will Meet Demand If Crude Supply Further Disrupted In Future?
With OPEC member nations pumping at full capacity, long-term capital intensive projects delayed or cancelled and demand growth continuing to increase beyond expectations, North American unconventional production remains the likeliest quick to market production available to prevent short-term shortage.
The Drillinginfo Index shows how much new US hydrocarbon New Production Capacity is created each month. The Index shows a rapid decline in new production capacity beginning in December 2015 but stability beginning in February 2016.
Should a new oil shock arise, North American unconventional producers will quickly react to bring new capacity online, a change that the Drillinginfo Index will capture in as it happens.
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