Only Recession Can Prevent An Oil Price Spike
The biggest result from the collapse in oil prices could be a future price spike.
Oil prices at $30 per barrel have put most producers under water. That has led to austere budgets and severe cuts to spending. Wood Mackenzie recently estimated that $380 billion in major oil projects have been delayed or cancelled since. That means that about 27 billion barrels that had been slated for production from those projects will now not be produced.
But more cuts are expected moving forward. “There has been a $1.8 trillion reduction in spending planned for 2015 to 2020 compared to what was expected in 2014,” historian and oil expert Daniel Yergin said at the World Economic Forum in Davos, according to the Telegraph.
The oil industry has long been spending beyond its means. The shale boom was made possible by the massive monetary expansion from the U.S. Federal Reserve since 2009, with near zero interest rates allowing nearly every mom-and-pop driller to access credit. The result was a surge in oil production. Many companies struggled to be profitable before the collapse in crude oil prices. Now most are losing money on every barrel sold.
But the problem is that the market will overcorrect. The $1.8 trillion cutback in spending that Daniel Yergin cites will lead to a shortfall in supply in the coming years. The world needs to replace about 5 percent of total production each year just from natural depletion. That is somewhere around 5 million barrels per day (mb/d) each year in new output.
Moreover, demand is expected to rise. The IEA says that oil demand grew by at a five-year high of 1.8 mb/d in 2015, and while that is expected to slow in 2016, the world will still consume an extra 1.2 mb/d of oil this year. That will continue to rise. Assuming a little more than 1 mb/d each year in new demand growth, the industry will need to supply an additional 7 mb/d by 2020.
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