Oil Prices Still Not Low Enough To Fix The Markets

The problem with oil prices is that they are not low enough.

Current oil prices are simply not low enough to stop over-production. Unless external investment capital is curtailed and producers learn to live within cash flow, a production surplus and low oil prices will persist for years.

Energy Is The Economy

GDP (gross domestic product) correlates empirically with oil prices (Figure 1). GDP increases when oil prices are low or falling; GDP is flat when oil prices are high or rising (GDP and oil prices in the figure are in August 2015 dollars).

Figure 1. U.S. GDP and WTI oil price. GDP and WTI are in August 2015 dollars. Note: I use WTI prices because Brent pricing did not exist before the 1970s. 

Source: U.S. Bureau of Labor Statistics, The World Bank, EIA and Labyrinth Consulting Services, Inc.

(click image to enlarge) Related: Oil Market Showdown: Can Russia Outlast The Saudis?

This is because global economic output is highly sensitive to the cost and availability of energy resources (it is also sensitive to debt). Liquid fuels-gasoline, diesel and jet fuel-power most worldwide transport of materials, and electricity from coal and natural gas powers most manufacturing. When energy prices are high, profit margins are lower and economic output and growth slows, and vice versa.

Because oil prices were high in the 4 years before September 2014 and the subsequent oil-price collapse, GDP was flat and economic growth was slow. That, along with high government, corporate and household debt loads, is the main reason why the post-2008 recession has been so persistent and difficult to correct through monetary policy.

Why Oil Prices Were High 2010-2014 and Why They Are Low Today

Brent oil prices exceeded $90 per barrel (August 2015 dollars) for 46 months from November 2010 until September 2014 (Figure 2). This was the longest period of high oil prices in history. Prolonged high prices made tight oil, ultra-deep water oil and oil-sand development feasible. Over-investment and subsequent over-production of expensive oil contributed to the global liquids surplus that caused oil prices to collapse beginning in September 2014.

Figure 2. Brent price in 2015 dollars and world liquids production deficit or surplus.

Source: EIA, U.S., U.S. Bureau of Labor Statistics and Labyrinth Consulting Services, Inc.

(click image to enlarge) Related: Downturn Hits Bottom But High Oil Storage Could Delay Recovery

Oil prices were high during the 4 years before prices collapsed because world liquids production deficits dominated the oil markets. This was due mostly to ongoing politically-driven supply interruptions in Libya, Iran, and Sudan beginning in 2011. The easing of tensions, particularly in Libya, after 2013 along with increasing volumes of tight and other expensive oil led to a production surplus by early 2014 (Figure 3). Before January 2014, supply was less than consumption but afterward, supply was greater than consumption.

Figure 3. World liquids supply and consumption, and Brent crude oil price.

Source: EIA and Labyrinth Consulting Services, Inc.

(click image to enlarge) Related: GE Spinoff Offers Investors Interesting Strategy During Volatile Market

The global production surplus has persisted for 21 months and supply is still 1.2 million barrels per day more than consumption. This is the main cause of low oil prices that began in mid-2014.

By Art Berman

More Top Reads From Oilprice.com:

• Is The Oil And Gas Fire Sale About To Start?
• VW's Dieselgate Scandal Could Cost Up To $87 Billion In Total
• Bearish Signals Quickly Kill Off Oil Price Rally