Posted May 10, 2018
The Wall Street Journal asserts the recent surge in oil prices caught forecasters by surprise. Although we at API do not forecast prices, we have discussed how market fundamentals – such as a tighter supply/demand balance and lower inventories compared with last year – have produced pressure for crude prices to rise. Other U.S. policy-driven factors also are at play, including a weaker U.S. dollar (which historically tends toward higher prices), and strained international relations that have compounded tightened market fundamentals. These come as no surprise.
The facts that crude oil prices are up 9 percent since the end of March and that crude oil currently accounts for 57 percent of the consumer’s price for gasoline mean that consumers have felt the impact at the pump of relatively large and sudden changes. As domestic crude oil prices recently increased above $70 per barrel for the first time since November 2014, let’s revisit current oil market fundamentals and other factors that have elevated prices.
By understanding the drivers of prices, American consumers may be more aware of how U.S. policy outcomes – such as more domestic natural gas and oil production, a strong U.S. dollar, low price inflation, avoidance of tariffs, quotas and other protectionist measures that undermine free trade, and peaceful international relations – could help put downward pressure on crude prices that ultimately benefits consumers.
The global oil supply/demand balance is a point of departure, and as the chart below shows oil prices have generally responded to the market’s net balance. For the past five consecutive quarters, the U.S. Energy Information Administration (EIA) estimates the market was in a slight deficit position, which in turn supported higher oil prices.
But oil prices also respond to many other uncertain factors, including current assessments and future expectations of seasonal, cyclical and structural factors – plus the prominent role of ROPEC (that is, Russia and OPEC together). Since Q3 2016, ROPEC have managed to keep 1.6 million barrels per day of supply off the global market, which with global demand growth has enabled supply and demand to re-balance but also has supported increasing prices.
The Trump Administration has blamed OPEC for higher oil prices. While it is true that ROPEC’s supply cuts have supported higher oil prices, the growth of global demand is the primary reason ROPEC has that degree of control. Between 2010 and 2017, global oil demand growth increased by an average of 1.3 million barrels per day (mb/d) in each year.
For 2018, the International Energy Agency’s expectation was that world oil demand would grow by perhaps 1.4 mb/d, with most all of this occurring within emerging economies. Through the first quarter of 2018, however, the United States’ oil demand was up by 1 md/d just by itself. While this certainly indicates the vibrancy of U.S. economic activity, as a country we also must recognize our part in the tighter supply/demand balance and encourage U.S. production growth to help meet demand growth, at home and abroad. This includes increasing access to domestic energy reserved onshore and offshore – the latter being especially important for long-term U.S. energy security.
The U.S. dollar foreign exchange rate is another factor. Mainly because oil is priced globally in U.S. dollars, there generally tends to be an inverse relationship between oil prices and the strength of the U.S. dollar’s exchange value. As of April 2018, the Federal Reserve’s estimate of the broad U.S. dollar index versus all trading partners showed that the dollar’s exchange value fell by 4.9 percent compared the same month one year ago. Based on the monthly data between 2013 and 2017, the depicted relationship suggests the fall of the U.S. dollar so far in 2018 could have added $1 per barrel or more to the global oil price.
Geopolitics also are front and center. Whether it be the continuing conflict in Syria, the ongoing crisis in relations among Gulf Cooperation Council (GCC) countries, or Saudi Arabia’s deflection of coup rumors (picture), there is no doubt that tensions in the Middle East have affected oil markets in ways not seen since 2014. Supply/demand fundamentals ultimately determine outcomes, but market sentiment can have a short-run impact. And this is occurring despite oil and refined inventories having remained in the middle of their five-year historical ranges, so it likely speaks to the severity of potential threats to the stability of Middle East oil supplies.
For American consumers watching gasoline prices, a primary focus should be domestic oil supply and policies that increase it. A major factor in declining gasoline prices from 2014 to 2016 was the growth of U.S. oil production and our ability to export some of it. Supporting local, state and federal policies that foster growth in U.S. natural gas and oil output – which are co-products in much onshore U.S. development – is job one.
Supporting trade policies that further enable U.S. energy development – from NAFTA, including its investment protections, to sensible trade policy and international relations that do not impose restrictions on steel pipe or other key inputs to the energy value chain – is another priority. The posture that the U.S. assumes in Middle East relations also matters to oil market dynamics, so viewing these issues with the big picture in mind could matter to prices and stability.
As U.S. fuel and import costs have risen, consumer price inflation has edged up each month this year (versus last year) from 2.1 percent to 2.4 percent in March. Since this pace exceeds the Fed’s target of 2 percent, there’s a good chance that this coupled with indicators of a tight labor market and wage inflation will continue to result in further Fed Funds rate increases. Historically, this situation sometimes re-strengthened the U.S. dollar and had some downward impact on oil prices, but the first-order impact is that U.S. consumers could pay an even higher price for their revolving debt and adjustable rate mortgages.
Advancing policies that foster stability in the broader sense but especially for global energy markets is pivotal. While the short-run is mainly about how much additional supply U.S. onshore production can bring, the long-term term concerns offshore production and access to resources. The U.S. needs access to resources in Alaska and the Outer Continental Shelf, which may take a decade or more to understand and consider safe and responsible development.
To bring it home, the strength of global and U.S. economic and energy demand means we need more energy of all forms as well as trade, financial and energy policies that enable it.
ABOUT THE AUTHOR
Dr. R. Dean Foreman is API’s chief economist, specializing in energy and global business. With a Ph.D. in economics from the University of Florida, he came to API from Saudi Aramco Strategy & Market Analysis in Dhahran, where he managed short-term market monitoring and the long-term oil demand outlook. Foreman has more than 20 years of industry experience in corporate strategic planning, forecasting, finance / risk management and regulatory policy at ExxonMobil, Talisman Energy and Sasol North America.