With each passing day, it seems that almost everyone in the financial world is waiting—wishing and hoping, really—for oil prices to recover. Due to a range of macroeconomic factors, this simply isn’t going to happen anytime soon, and certainly not to the levels seen last summer, when a barrel of crude oil was approaching $120. Today, the same barrel of crude is more than 60% cheaper.
One group that is certainly not complaining is the consumer: all over the world, automobile drivers are filling up their tanks for a fraction of the cost they did so one short year ago.
Explaining the Producer Squeeze
Many oil refiners and drilling operations were forced to cut expenditures and, in some cases, mothball their operations altogether due to the precipitous drop in oil prices that kicked off last year. This trend accelerated due to a bona fide “squeeze play” put on by the two key groups of producers in the global oil industry—shale miners in the U.S. and the traditional producers in the Middle East, largely represented by the Organization of Petroleum Exporting Countries (OPEC). As prices dropped, OPEC members (particularly Saudi Arabia, who holds the most sway in the oil cartel) continued to pump oil at an ever-quickening pace, adding to an already massive global oversupply of crude. This drove prices lower still in an attempt to push the shale industry out of the market.
Yet, this is where OPEC’s plan—a very open and public plan, no less—fell apart. Although many of the shale oil fields were abandoned due to the price war, this only pushed a few of the weakest firms out of operation. Meantime, several of the stronger shale mines were able to remain profitable even at such low price levels thanks to advances in fracking technology and great leaps in efficiency.
Only the Strong Survive
In effect, the OPEC price squeeze had its intended outcome, but on the wrong rival. Smaller producers in the arctic and in temperate jungles were the ones driven out of business by the aggressive war for market share, as these oil companies had no means of remaining profitable at such low commodity prices. The advantages that keep U.S. shale and OPEC afloat are the former’s technological advancements and the latter’s easy access to rich deposits in the Middle East; minor producers had neither of these strengths to fall back on when prices collapsed far below expected levels.
Russia in particular was hit hard. Although it is still one of the world’s largest suppliers of energy resources, the fledgling economy prevents Russian oil companies from updating their processes and retooling with more modern technology in order to cut costs and improve the efficiency of their operations.
OPEC must also deal with the problem of Iran, a member of the group who has been forced to idle millions of barrels of crude oil while under economic sanctions from the West. If the Iran nuclear deal goes through and sanctions are lifted, OPEC must deal with this Iranian oil now hitting the market. Algeria, another OPEC member, has made an appeal for the world’s other producers outside of the oil cartel to cut their own production in order to lift prices, though it is highly unlikely that anyone will accommodate this request.
The chances are high that countries like Saudi Arabia and its OPEC partners can weather the storm of the current price environment by high-grading their reserves, pumping the richest deposits now with the expectation that prices will recover in the future. This stop-gap can only sustain them for so long, however; with concerns that demand for oil is weakening in Japan and China (the world’s third- and first-largest importers), relatively cheap crude oil prices may be here to stay for longer than some oil exporters would hope. Moreover, if major producers are relying on high-grading, they are hurting their growth prospects for the long run.