Bloomberg carried a report late last week titled “Goldman Says Oil Market’s Too Jittery When There’s No Need to Be.” The report summarized a memo from Goldman Sachs analysts positing that the just-completed extension of the deal between OPEC and Russia to limit oil exports “indicates a reduced risk of both unexpected increases in supply as well as excess draws in stockpiles.”
The report didn’t address the reality that one of the main reasons why the crude markets remain jittery is very likely due to all the conflicting reporting in the energy-related news media leading up to that extension. While there was never any real, firm reason to doubt the extension would get done, pretty much every day in November was filled with speculative stories with click-bait headlines expressing doubts the parties could reach agreement.
While this is just the nature of the U.S. news media in general these days, the reality is that there has been precious little volatility in crude prices throughout the second half of 2017. In fact, on June 19, I wrote the following:
That’s exactly what has happened as these large independent producers scaled back their drilling budgets for the second half of this year, and it’s the main reason the frequent ups and downs in crude prices that had characterized the previous two-plus years have been replaced by what has been a steady rise in prices over the last five months. The key understanding to grasp in this equation is that, once OPEC and Russia agreed to artificially limit their exports, U.S. shale producers then become the de facto swing producer on the global stage.
It was clear in June that these producers would scale back their drilling during the 2nd half of the year because the rapid up-tick they had implemented during the 1st quarter of the year — when almost 300 active drilling rigs were added in the U.S. — had resulted in a drop in the WTI price from $53 at the beginning of the year, to about $44 by April, when the 2H 2017 budget reviews were conducted. Lower price = less incentive to drill, which in turn = scaled back drilling plans. Simple.
This period of stable rig counts and a slowing of the rise of overall U.S. crude production has now allowed the market to essentially re-balance at long last, yet, as Goldman’s analysts point out, the markets remain jittery. Who can blame them? The last few years have left a lot of people shell-shocked, and the seeming unpredictability of U.S. shale producers, and the lack of any government mechanisms to control their output no doubt leaves most investors, brokers and analysts with a great deal of uncertainty about where prices and production and inventories will head in 2018.
The thing is, though, these companies really aren’t unpredictable at all, when you understand how they budget and deploy capital. As I pointed out in early November, “the upstream industry has always been price-responsive, and that won’t change in 2018. We can be sure, with the price for WTI at the strongest level it has seen in two years, that companies are today putting in place strong drilling budgets for the first half of 2018. Those budgets will no doubt create another uptick in the domestic rig count during the first quarter of the year” and will lead, at least to some extent, to higher U.S. production. That rising production will put downward pressure on prices during the first half of next year, though not as severely as took place during the first few months of 2017, for reasons I detailed in that previous piece.
There is no great mystery here — it is what it is. What everyone interested in the oil markets should realize by now is that, by entering into their export limitation agreement, OPEC and Russia have been responsible for stabilizing a crude market that had, for more than two years, been wildly unpredictable. While you can’t blame investors who had been whipped mercilessly by that high volatility for still being jumpy about things, Goldman’s analysts are exactly right when the point out that that nervousness is largely unwarranted at this point.
Of course, that message doesn’t make for good click bait, so we can expect all the wild, conflicting reporting in the media to continue. There is no great mystery there, either.