Oil has been whipsawing all over the place lately. For the last several weeks, oil has mostly fallen, with some short term big rallies along the way. One of those was just a couple days ago when Saudi Arabia and Russia announced an agreement to cut output. However, the bottom has fallen out of the commodity as Saudi Arabia’s energy minister announced that he would only favor a small cut. This led to big doubts about whether the efforts will actually lower supply, sending prices spiraling down 5%.
FINSUM: This seems to be a direct consequence of the US’ ability to boost its production to offset any declines by OPEC. Accordingly, Saudi Arabia doesn’t want to lower its revenue by cutting only for the US to take advantage.
If you haven’t been paying attention, something very interesting has been happening in the oil market. That development is that the US has quietly replaced Saudi Arabia as the world’s largest oil producer. That is a major development because the US is outside of OPEC and thus is a major counter-balance (headache) to Saudi Arabia and OPEC’s ability to control oil prices. Each time Riyadh wants to cut output to boost prices, the US can raise its production to offset the cut.
FINSUM: The US is in a strategically superior position for the first time in a very long time. This whole dynamic is symptomatic of the new era of bountiful oil. We ultimately believe that prices will stay well below $100 for several years to come because of how supplied the market is.
The oil market has been in an extremely rough patch over the last several weeks. Just a couple months ago, many were talking about the return of $100 oil. Suddenly, prices are just half that. The question is where is crude headed next. Well, the Saudis seem committed to keeping it weak, as the Kingdom, which leads OPEC, has just announced that it will not cut production. The catch is that it said it will not do so alone, which keeps the door open to another coordinated OPEC-wide cut, such as happened several months ago.
FINSUM: The big difference between a coordinated cut now and the one from a couple years ago is that the world looks much closer to recession a present, which means demand could flatten or fall even if output lowers. That means producers could lose revenue by cutting (instead of the difference being made up by price gains), which makes a big difference.
When oil falls it tends to boost the US economy. For all the growth of our shale industry, the US is still a net importer of oil. When prices fall, Americans tend to spend more on other items that boost the economy, so oil prices sinking is usually good news. However, this time around, the fall will be bad, at least according to the Wall Street Journal. The problem is that the oil industry has grown large enough that capital expenditures in the sector make a major impact on growth. Accordingly, the capex cut that will come from falling prices will be prove a net detriment to GDP figures.
FINSUM: When oil fell in 2014-2016, US economic output also slowed, so this is a very real affect. What is worse is that it will likely show up in 2019, which is already looking to be a much weaker year.
Oil, like many other commodities, is seen as a good leading indicator of the economy. Because it is a strong gauge for total economic demand, it functions are a good bellwether of future growth. However, Barron’s is arguing that, right now, the signal is broken. There are a number of reasons why. The foremost of them are that the recent moves in oil have much more to do with supply growth and geopolitics than they do with economic demand.
FINSUM: Oil is not a good barometer of the economy right now because of its own issues. The oil market has changed dramatically in the last decade because of the huge expansion of oil reserves due to shale. That has led to the whole sector recalibrating itself. As evidence of this argument, take for instance the fact that oil suffered an extreme bear market from 2014-2016, but the global economy kept expanding nicely.