If history is a guide, an oil price boom is coming after the pandemic-generated crash.
While the near-term demand picture is highly uncertain, as people reconsider their travel and work habits, this latest bust, the worst of them all, is unlikely to hasten the demise of oil.
“The only way to get away from the boom-bust cycle is to get off of oil,” said Bob McNally, president of Rapidan Energy Group and the author of a book on the topic called Crude Volatility. “That’s really tough because there are no scalable substitutes. As a result, we expect a thirstier world will collide into insufficient supply, and crude prices will have to rise sharply to balance the market.”
Oil supply will take longer to return than demand as drillers shut-in a record amount of production, companies cut spending on new investments, and the U.S. shale revolution slows.
“As demand rises and it becomes clear that producers over-cut, a roaring oil market will develop,” said Dan Eberhart, CEO of the drilling services company Canary and a donor to President Trump.
Few are expecting $100 per barrel oil, a level that was commonly reached during previous economic recoveries but hasn’t been met since summer 2014. Oil prices have increased in recent weeks, with the U.S. benchmark closing this week at $24.74 per barrel after briefly trading below zero last month for the first time. Joe McMonigle, president of the Abraham Group, an international strategic consulting firm, said he expects oil prices to reach around $45 per barrel as early as the third quarter of this year as economies are freed from stay-at-home orders.
He noted oil prices approached $80 per barrel as recently as last year.
“I hesitate to talk about $100 oil,” said McMonigle, a former Energy Department chief of staff in the George W. Bush administration. “But when the economy comes back, you will eventually get to that bust to boom cycle.”
At first glance, the outlook for oil demand is cloudy, and there are countervailing factors that might determine its future. China, one of the two biggest oil consumers with the United States, is back to rush-hour traffic levels after beating the worst of the virus.
Driving is picking up in the U.S. as nearly half of states have begun to open stores, beaches, and restaurants. But flying remains risky and is discouraged. For many, telecommuting is normal now and could become more routine in the future. Mass transit, powered by electricity, not oil, could see a hit as people avoid tight spaces. That means more cars on the roads.
“You have trends both negative or positive for demand, and it’s anybody’s guess which way that pushes demand,” said Jim Krane, energy geopolitics fellow at Rice University’s Baker Institute. “I have seen nothing that tells me there will be a permanent drop in oil demand.”
Global oil demand is not expected to reach pre-pandemic levels before the end of the year, the International Energy Agency projected last month. But after that, it expects oil demand to experience “robust” growth to 2025, absent major changes in government policies, before seeing slower growth and reaching 106 million barrels per day in 2040. The world consumed 100 million barrels per day of oil before the pandemic.
“Oil is still the only game in town when it comes to moving around the planet, and until that changes, we are going to be using it,” Krane said.
Supply is set to recover slower than demand, putting upward pressure on prices.
There will be 14 million barrels per day of crude oil production cut or shut-in worldwide in the second quarter of this year, the research group IHS Markit projected Friday. That involves a mix of government-mandated cuts in places such as Saudi Arabia and Russia and market-driven ones in the U.S., the world’s largest oil producer. There were 374 active drilling rigs in the U.S. as of Friday, 614 less than a year earlier — a level not seen since before the shale revolution.
“The biggest factor outside of demand is how U.S. shale comes back,” said Sarah Ladislaw, director of the Energy Security and Climate Change Program at the Center for Strategic and International Studies.
Shale production can be turned on and off quickly.
“The physical challenge of bringing back shale oil can be easier than people currently imagine,” said Amy Myers Jaffe, director of the Energy Security and Climate Change Program at the Council on Foreign Relations, crediting technological advances, the geology of shale, and automation.
But Jaffe said restoring shuttered wells is an “expensive proposition.” For example, North Dakota has reported a shut-in of more than a third of active wells, nearly 7,000 of them, leading to a 450,000 barrel per day production drop in the state’s Bakken shale basin. The cost of returning a Bakken oil well to production ranges from $25,000 to $50,000, according to state figures — a cumulative cost of $170 million to $340 million.
Other big producing countries with oil-dependent economies such as Iraq and Nigeria will struggle even more to restore production to previous levels, Jaffe said.
“There is a long period of time for countries that had setbacks to restore capacity to its full level,” she said.
Oil companies, meanwhile, are cutting new investments.
Global capital spending by exploration and production companies in 2020 could fall 32% to $335 billion, the lowest level for 13 years, the IEA said.
“The industry is not investing nearly enough to meet future demand growth,” McNally said.
As oil prices rise when supply lags demand, the U.S. shale industry will be positioned to pick up again, but at a slower and steadier rate, analysts say. The shale that emerges will be consolidated, with smaller inefficient producers being eaten by bigger ones that have more spending discipline.
But around one-quarter of shale production was likely uneconomical before the price crash, said Jason Bordoff, founding director of Columbia University’s Center on Global Energy Policy.
“Following a wave of bankruptcies and consolidation, shale will still be a major force, but with some of that irrational exuberance gone, it won’t grow at the same rate as before,” said Bordoff, a former energy adviser to President Barack Obama.
McMonigle, however, said shale producers won’t be able to resist high prices.
“If oil prices are at $100 a barrel, or close to it, shale production will respond to that,” he said.
And if that happens, the boom-bust cycle continues.
“In reality, the oil market is never really balanced,” McNally said.