Markets Unprepared For $80 Oil Shock

May 17, 2018

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The summer driving season is just around the corner and this year motorists are facing steeper prices for fuel, up from an average of $2.19 a gallon in 2016 to $2.87 today. By this summer, analysts are projecting gas prices to top $3 a gallon on average for the first time in 10 years.

Forces Driving Oil Prices Higher

We’re at $71 a barrel for oil right now, up from the low of $26 a barrel hit in February 2016. That's an increase of 173% in the last two years, and with President Trump pulling out of the Iranian deal, we’re likely to see more price increases soon.

Many tend to think of oil as driven by supply and demand, but there is much more to the oil markets.

“It's not just demand, which has risen just about every single year,” Financial Sense Newshour's Jim Puplava said. “Demand this year is expected to grow by 1.6 million barrels a day and finish out the year with demand at 100 million barrels a day of consumption.”

Oil supply is also adding to pressures, as the glut of the last few years is reversing. It was precipitated by the Saudi Arabian and OPEC decision to overproduce in the hope of cutting off US shale production. This backfired, however, and many US shale producers are claiming profitability at between $40 and $30 oil prices. As a result, OPEC has cut production by 1.8 million barrels.

But these factors aren’t the only important forces driving oil prices higher.

Geopolitics Taking Center Stage

With high inventory levels in the last couple of years, any kind of shock or disruption in the Middle East had little impact on the market, Puplava noted.

Now, with production coming into balance, the potential of a supply shock coming from the developments around Iran coupled with continued plunging production from Venezuela is increasingly likely.

Venezuela's oil production is down by a million barrels and there's a possibility that oil production could drop by as much as another million barrels depending on how sanctions play out with Iran, Puplava noted.

On top of this, global oil markets are facing an average deficit right now, Puplava added, not counting the precipitous drop in Venezuelan oil production.

“Oil prices could go up another $10,” Puplava said. “We're looking at $71 a barrel right now. We could be looking at $80 a barrel, and I don't know if the markets are ready for that.”

Shale Oil Not A Savior

Many expect that higher prices will bring more shale production in the US out of the woodwork. But it isn’t that simple, Puplava noted, not because of production constraints, but because of issues with distribution.

The problem with shale is transport to the market, he noted. They’re facing bottlenecks in Texas because pipelines are crowded and there’s a shortage of oil workers.

As a result, shale oil is selling at a steep discount to West Texas Intermediate crude, Puplava stated, as oil output in the region is overwhelming pipelines.

Unfortunately, it's going to take several years before new pipelines and necessary infrastructure help alleviate this problem.

“Oil analysts expect that close to 200 million barrels of oil will be unable to make it to the markets in the next 16 months,” Puplava said. “Oil, which has been a laggard out of favor, is now back at the forefront. … That's generally what happens in the oil industry. We tend to go from extremes on the low end to extremes on the high end. From the way things look right now, we may be looking at another oil shock with oil prices heading to $80 a barrel.”


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