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James Hamilton

James Hamilton

James is the Editor of Econbrowser – a popular economics blog that Analyses current economic conditions and policy.

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Seeing Beyond Sentiment In Oil’s Latest Rally

Seeing Beyond Sentiment In Oil’s Latest Rally

Today I discuss the factors that brought oil prices so far down and more recently back up.

World oil production was essentially stagnant for seven years beginning in 2005. Field production of crude oil averaged 73.9 million barrels a day in 2005 and averaged 74.7 mb/d in 2011.

Monthly world field production of crude oil in thousands of barrels per day, Jan 1973 to Nov 2015. Vertical line at Jan 2012. Data source: Monthly Energy Review. Related: The Forgotten Shale Boom Towns

That plateau was followed by a dramatic surge in world production of 3.1 mb/d between January 2012 and January 2015. More than all of that increase can be accounted for arithmetically by the 3.2 mb/d increase in U.S. production, spurred by horizontal fracturing of shale formations. Net production outside the U.S. actually decreased 100,000 b/d during these 3 years, though far from uniformly across producing countries, with 800,000 b/d increases each from Iraq and Canada helping to offset production declines in places like Libya, Iran, and Mexico.

Monthly U.S. field production of crude oil in thousands of barrels per day, Jan 1973 to Nov 2015. Data source: Monthly Energy Review.

U.S. production continued to rise in the first few months of last year, but fell almost 400,000 b/d between March and November to end the year about where it began. The EIA’s Drilling Productivity Report model predicts that field production from the major U.S. shale plays will have fallen another 400,000 b/d from November values by April. Last week the Wall Street Journal passed along this assessment:

In the Bakken Shale region, prices will need to be above $60 for benchmark West Texas Intermediate crude for at least three months before the area sees a meaningful uptick in drilling activity, said Lynn Helms, Director of North Dakota’s Department of Mineral Resources.

Actual or expected average daily production (in million barrels per day) from counties associated with the Permian, Eagle Ford, Bakken, and Niobrara plays, monthly Jan 2007 to Apr 2016. Data source: EIA Drilling Productivity Report.

But despite the situation in the U.S., world production of crude oil increased another 1.1 mb/d in the first 11 months of 2015. Here the big story has been Iraq, whose production was up almost 1 mb/d even though ISIS continues to control large non-oil-producing sections of Iraq.

Monthly Iraqi field production of crude oil in thousands of barrels per day, Jan 1973 to Nov 2015. Data source: Monthly Energy Review. Related: An Output Freeze Is Still The Big Red-Herring For Oil

Saudi production was 400,000 b/d higher in November than in January, though that just leaves its current monthly production within the range we’ve been typically seeing over the last three years.

Monthly Saudi Arabian field production of crude oil in thousands of barrels per day, Jan 1973 to Nov 2015. Data source: Monthly Energy Review.

Another key factor keeping oil prices low has been Iran. The country claims to have increased production by 400,000 b/d since sanctions were lifted in January, and has plans for further increases. However, so far Iran has been encountering some logistical problems in selling the oil.

It’s important to emphasize that it’s not just developments on the supply side that have been driving recent oil price movements. The graph below compares the prices of a number of commodities over the last 16 months, which share not only the same dramatic downward trend, but also all experienced price rallies in the spring of last year and again over the last 2 months. This is true not just for the dollar price of copper, silver, lumber, and cattle, but for the dollar price of the euro as well.

(Click to enlarge)

Weekly futures prices, Oct 2014 to Mar 2016. Source: Financial Visualizations.

The recent co-movement between the dollar price of oil and the dollar price of the Chinese yuan is even more striking, as plots of the cumulative percent change (measured in 100 log points) in those two series since Sept 2014 demonstrate.


(Click to enlarge)

One hundred times the cumulative change since Aug 29, 2014 in the natural logs of the spot price of West Texas Intermediate (left scale, from DCOILWTICO on FRED) and of the dollar price of a euro (right scale, from reciprocal of DEXCHUS on FRED), daily, Aug 29, 2014 through Mar 11, 2016. Related: The Unexpected Threat To Our Economic Growth System

Note well that the above graphs do not imply that oil prices did not change if you measured them in euros or yuan. Oil prices and exchange rates in the two last sets of graphs have been plotted on very different scales. The price of oil is up 44 percent since January 20, but the euro has only appreciated by 2.5 percent and the yuan by about 1 percent since then. While it is certainly not the case that movements in the exchange rate are the cause of movements in the price of oil, it is quite clear from the graphs that these variables are responding to some common forces.

One important common factor is concerns about economic weakness in Europe and China, which contributed to their weaker currencies relative to the dollar as well as to slower growth in forecast oil demand. But is there evidence that the economic outlook has improved over the last two months? Chinese leaders have been suggesting that is indeed the case, and IMF Chief Christine Lagarde is encouraged by recent policy moves in Europe, Japan, and China. But many other observers remain pessimistic.

Another factor in the recent retreat of the dollar could be the Fed’s move toward a more dovish posture for 2016. Some have argued that this could mean a faster economic growth rate than might have been forecast in December and thus more robust oil demand. On the other hand, the reason for the Fed’s change would seem to be newly perceived weakness in some of the U.S. and global economic indicators.

To summarize, strong supply and weak demand contributed to the collapse of oil prices through the first part of this year. Which if either of those fundamentals has changed since then is substantially less clear at this point.

By James Hamilton via Econbrowser.com

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Leave a comment
  • James Hilden-Minton on March 21 2016 said:
    Hamilton fails to make a distinction between general economic demand and specific demand for oil. This may have made sense in an age of oil dependency, but increasingly the global economy is able to grow even as demand for oil and other commodities decline. Technology, energy efficiency and renewable energy all undercut demand for fossil fuels. A better analysis will be required going forward.

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