Crude oil prices have had their ups and downs (mainly downs) in recent years, falling most recently by close to 4% during the week that began 19 June 2017. While this hit the valuations of oil-linked assets such as some Emerging Markets (EM) currencies, the effect on broader risky assets has been fairly muted.
The moves in market prices suggest to us that the correction in prices has been driven by concerns over ample supply rather than insufficient demand.
Expectations of an extension of OPEC production cuts supported prices until mid-May. However, prices subsequently fell rapidly after OPEC announced on 25/05/17 an extension of production cuts by a further nine months. The bar is therefore quite high for further cuts to curtail supply by the cartel, at least in the near term.
In contrast, in the US, crude production rose to a fresh year-to-date (YTD) high in mid-June and inventories remain historically very high. Production is up 7% YTD, while West Texas Intermediate (WTI) prices are down close to 20% (from around USD 55 to USD 43/bbl).
A key concern is that shale production costs are low enough to support plenty of production even with prices below USD 50/bbl. Research from Barclays, for example, shows that 80% of the cost base is below USD 60/bbl, but at USD 43/bbl only 35% of exiting oil fields would breakeven. The glut in supply therefore now appears to be largely incorporated into current valuations.
Click here for a global view on the factors affecting the oil industry.
