This eye-catching graph pops out of a report published by Boston Consulting Group on January 21: it illustrates how the current oil price crash, while not (yet) the deepest in recent memory, is the longest-lasting—and counting. In the past two decades, anyway, a bottom has been found after four to six months. We’re now into the eighth month of this bust, with no floor in sight.
There are two reasons for this. First, this crash is more about supply than demand. During the 2008-09 slide, it was the other way around; then, as soon as the global financial crisis was contained and energy traders could see the level at which global demand would bottom out, the price trend reversed itself. Such is not the case today. Crude oil demand is steady, if tepid. What’s driving the price down is the increase in supply.
Which brings us to the second reason for the long duration of the drop: the supply side is not as responsive to price signals as it used to be. In the past, when virtually all oil production was “conventional”—that is, land-based or in shallow water, and accessing underground lakes of oil—a company faced with falling prices cut its capital budget and drilled fewer new wells. The wells already in operation would produce less and less every month as the lakes became depleted, and before long industry-wide production would fall, or slow sufficiently for demand to catch up.
Now, outside of the Middle East and remote or war-ravaged locations, those lakes of oil are gone. What’s left are more like ponds, or puddles, or even droplets clustered in solid rock, and the capital cost and time frame to extract oil from them have soared. Note that’s capital costs, not operating costs. If anything, the practice of pumping a well is more automated than ever; the costs are mostly up front.
Many North American producers have already spent 75% to 90% of the per-barrel cost of a project before recovering their first barrel, and in the case of the oilsands, it might have taken 10 years. So they can’t cut output in a matter of months. By slashing capital costs as they are (necessarily for financial reasons) doing, they are cutting production literally years in the future. (This potentially sets us up for a price spike three to five years out due to underinvestment now.)
The only major suppliers still capable of turning the taps on and off in short order are the Saudis, and they are keeping them on. The hard fact for North American producers is only now are we seeing a true market price for crude oil. Previously, OPEC members withheld their full capacity, making so much unconventional production in North America economic. It’s not now, and it likely won’t be for a long time.
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