The price of crude oil has had some sharp swings over the last month. But the trend since January has clearly been up.
World oil production barely increased between 2005 and 2013, a period of strong oil demand from emerging economies. That combination supported an undulating price plateau around $100/barrel. The price ceiling was broken by a surge in world oil production beginning with prolific U.S. shale oil development.
Global oil production was carried further upward by Iraq, where postwar investments started to yield results in 2014, and by the lifting of sanctions on Iran last winter. These two countries today are producing 2.2 mb/d more than they were at the start of 2013.
And the new U.S. fields that were the original source of the global production gains aren’t profitable at $40/barrel. U.S. production is now down 700,000 b/d from where it had been early in 2015. The net result is that despite the gains from Iraq and Iran, total world oil production this May was 700,000 b/d lower than it had been at the start of 2015.
The price of West Texas intermediate is now at $45/barrel, up 20% from the start of the year. For several years now I’ve been using a simple statistical model to judge how much of a given move in oil prices might be attributable to demand factors. The model calculates how much of the change in the price of oil could be explained statistically by copper prices, the exchange rate, and nominal interest rates, the assumption being that movements in these variables are mostly driven by factors other than oil supply. When I updated that calculation using the latest data (as you can do yourself with the calculator here), I found that essentially all of the oil price increase during calendar year 2016 should be attributed to supply factors, and none to demand factors. Although the weakening of the dollar during this year would be consistent with rising oil prices, both copper prices and interest rates fell, which normally would be associated with lower oil prices. The result of the three factors together is a net wash, causing the model to conclude that changes on the demand side do not explain any of this year’s move in oil prices.
In other words, the forces of supply and demand are at work, as always. Advances in fracking along with geopolitical stability (for now) in the Middle East brought prices down well below the marginal production cost. As some of the higher-cost production was curtailed, and as fresh geopolitical turmoil has emerged in Africa, prices have climbed back up.