In February of 2014, a barrel of Brent crude, the world’s leading benchmark, fetched over $100/barrel. Today, the same barrel of Brent crude goes for $30/barrel. Over the course of the past two years, supply overwhelmed demand and a massive oil glut emerged to depress prices.
High prices in the early 2000s coincided with a technological explosion that combined horizontal drilling and hydraulic fracturing. This combination, predominately exploited in United States shale plays, drastically increased domestic output. West Texas Intermediate (WTI), the domestic crude benchmark, historically traded at a discount to Brent crude. The two benchmarks were almost equal in 2015.
The increase in United States oil production was noticed by the Organization of the Petroleum Exporting Countries (OPEC). Instead of curbing production to prevent a supply surplus, OPEC ramped up production and created a price war to defend its market share. The oil price war has certainly become one of attrition, as Saudi Arabia is expected to register a 13% trade deficit in 2016, exploration and production company bankruptcies are expected often, and price rebounds are nowhere in sight.
OPEC countries have begun to rethink their production strategies. For the first time in 15 years, Saudi Arabia, the essential OPEC leader, met with Russia to discuss a production cap. If a deal goes through, Qatar, Venezuela, and most recently Nigeria, have all agreed to freeze production at January levels. The deal, however, is far from likely, as Iran argues it should not be forced to freeze output at the same levels as other OPEC countries. Iran has been unable to export oil as a result of economic sanctions. Now, with those sanctions lifted, Iran looks to ramp up production and regain market share.
Time will tell if OPEC and Russia are able to successfully strike a deal. Even if they do, it is uncertain how global supply will be affected. With so many wells temporarily shut down, any significant price increase will result in domestic and international producers bringing wells back online and again increasing supply. What can not be precisely evaluated is how the oil price war will affect regional conflicts in the Middle East. Conflicts in oil producing countries such as Syria, Libya, and Yemen have already caused unexpected production disruptions. If prices continue to stay low, tensions will continue to mount.
Domestically, shale producers have struggled to keep their balance sheets in check. Many producers took on huge amounts of debt when oil prices were high. Today, many of these loans are coming due and companies will face difficult restructurings. Certain projections expect a wave of mergers and acquisitions similar to the late-1990s to sweep the industry. For now, price volatility has created stagnation, as energy mergers and acquisitions were down 30% in 2015.
The outlook for many is bleak right now. But the energy industry is cyclical. Demand will increase, as low prices encourage consumer spending and the Chinese economy stabilizes. Supply will decrease, as expensive production fields become illogical to produce. All of this will undoubtedly happen; it is just a question of when.