The next big move in the price of oil will be up. For now, OPEC producers are flooding the market with cheap crude. But low-cost OPEC producers will win the hydrocarbon price war because they can fight harder for longer. And when they win, the price of oil will rise.
Brent crude has fallen about 40 percent over the last year to less than $40 a barrel as the Organization of the Petroleum Exporting Countries has sought to defend its market share by pumping record volumes of oil and driving profit out of higher-cost production. Shale oil drillers in America and offshore operators in areas such as the UK’s North Sea are among the most vulnerable. Improving wellhead efficiency has softened the blows thus far. But these gains will be harder to repeat in 2016.
The International Energy Agency (IEA) expects shale oil production in the United States to shrink by more than 600,000 barrels per day next year if current low oil prices persist. At that rate, daily U.S. shale production would soon fall below 5 million barrels per day.
Lower prices will accelerate shutdowns in areas like the North Sea too. Energy consultancy Wood Mackenzie reckons that over a third of the area’s 330 fields could be threatened by early closure if prices remain below $85 per barrel for an extended period.
Like shale, the North Sea was once seen as a serious rival to OPEC’s cheap oil but now it looks like its first victim. Wood Mackenzie reckons that at least 1.5 million barrels of daily global production are uneconomic at $40. Those volumes make up no more than a couple of percent of supply. But the global oil market is finely balanced. Small changes can lead to big shifts.
As more high-cost production is either shut down or slowed down, OPEC’s pricing power will come to the fore. The IEA says oil prices will swill around the bottom of the barrel until 2018. If demand for oil rises with a global economic growth spurt – fuelled perhaps by the low cost of energy – the oil prices will move up sooner than that.
The precise price to be seen at any moment in 2016 is unpredictable. But elemental oil market forces suggest that a barrel of black stuff will revert back towards its 10-year mean above $80.
This view is a Breakingviews prediction for 2016. Click here to see more predictions.