Oil’s Ups and Downs

The price of oil rose sharply last week to nearly $40 a barrel, presumably based on two pieces of information: falling rig counts in the United States and the announcement that major international oil exporters Saudi Arabia, Russia, and Venezuela would freeze oil production if other oil producing countries agreed to the same. The rally seemed genuine enough that even the IEA stated in its March monthly oil reports that, “there are signs that prices might have bottomed out.”

The problem with this oil rally (which already proved transient) is that the forces that drove oil up to $40 are not really indicative of a change in the oversupplied market.

Oil rig count in the United States has been dropping steadily in 2016, while oil production has remained steady. Rig counts are released weekly but do not provide a good indication of oil production in the United States, because the rate of production from rigs already in use has climbed steadily. Oil storage facilities present a much more accurate indicator of the amount of crude oil in the U.S. These storage facilities are so fully stocked that overflow is being stored in railcars. The significance of this cannot be understated – there is so much pumped oil in the United States that there is nowhere to put it. Even ending the oil export ban has not helped because the global market is nearly as over supplied as the U.S. market, and U.S. oil is struggling to find outlets internationally.

When it comes to the so-called “production freeze,” the truth is that the market should have known better. Talk of an agreement to hold oil production at current levels has been floating around since the beginning of 2016, and every time Russia, Saudi Arabia, Venezuela, Iraq, Qatar, the UAE, Oman and others meet secretly in some combination the same theme emerges. It goes like this: the big producers will only agree to a freeze (not a cut) if everyone else – including wild-card Iran – agrees as well.

Meanwhile, Iran has stated unequivocally that it will not freeze crude oil production, at least until its export numbers return to pre-sanctions levels. How long this may take is unclear, particularly because Iran is clearly struggling with old and inoperative equipment. In this respect, however, we can take Iran at its word. The country’s stated intentions and its interests are clearly aligned when it comes to oil production. Regardless of the low price that oil may fetch, any sale is better than no sale. The same holds true for all of the big producers, which is why any firm and final commitment to a production freeze is highly unlikely to succeed in the current market.

Another sign that any semblance of international cooperation for a production freeze will fail is the news that the Italian oil company, ENI, recently started to produce oil from the world’s northernmost offshore oil platform. Production from this source has been a long time coming – the project is two years overdue – and ENI will almost certainly want to pump and sell as much as possible to offset $6 billion the company already invested in this Arctic platform. ENI is a major international oil company, but the company is not big enough to hold off on production from such a large investment. Such is the nature of the oil industry – only the strongest players can afford to actually cut production.

Even though the charts and graphs have indicated a sustained upward trend in crude oil prices over the past month, the situation on the ground – or rather, in the tankers, railcars, and pipelines – has not changed much at all. The only ways the supply glut will truly ease is through increased demand (which is what OPEC predicts according to its latest monthly market report) or decreased supply (which is what may happen as smaller companies face bankruptcy and sales and larger companies cut expensive exploration and production projects).

Until then, everything else – coordinated supply cuts or freezes, falling rig counts, and Venezuelan pressure on OPEC – is just speculation.