The oil market of today and tomorrow is a dynamic place where technology, speculation, risk and the basic economic principles of supply and demand converge to manage the fuel that powers the global economy. And a significant portion of oil production, innovation, and trading is in the United States.
But to understand where the oil market is headed, it is critical to understand the recent past, and that as recently as 2005, it wasn’t this way. In fact, thirteen years ago, the United States oil sector needed nothing short of a miracle.
By that time, domestic production had declined for 35 straight years after reaching a peak in 1970. The US was importing massive quantities of “foreign oil” from dangerous places across the world. Prices soared, debates about energy policy raged, and no one was comfortable with the direction of things. A perplexing brew of geo-political factors continually exerted undue influence on global oil markets.
Talk of peak oil, a once radical idea that the world had already passed a peak in oil production, began to be widely discussed and the concept began to be accepted as conventional wisdom.
Prices were hard to call, trends were confusing and traders were as perplexed as consumers were frustrated.
The Shale Oil Miracle
But then, ten years ago, when the oil sector in the US could not get any more anemic, the earth beneath the oil and gas sector shifted.
Growth in U.S. production started to take flight in 2008, and the next seven years of activity sparked a rebirth in drilling in the United States as we witnessed the fastest production increase in U.S. history. Reversing thirty five years of declines, production of crude oil and natural gas came roaring back and sky rocketed by a massive six million barrels per day according to the US Energy Information Administration (EIA).
The catalyst for this transformation was good old fashioned American innovation.
Oil producers had set about to find a way to economically extract oil from tight shale rock formations. They knew the oil was there, and lots of it, and they knew there were ways to siphon it out, but it required ingenuity and innovation to determine how to do it cost effectively.
When they did, it proved to be nothing short of the miracle the industry needed.
An American Oil Drilling Renaissance
Shale oil quickly dominated. Like Muhammad Ali making a triumphant return to the ring to take on George Foreman, American oil producers piled back into projects looking to take advantage of high prices and new technology to ramp production and knock the competition flat on its back as swiftly as possible.
What we witnessed was the early first act of a full blown renaissance of American oil production. It harkened back to a time when risk indulgent drillers gambled on projects with the faintest whiff of hydrocarbons with the sole intent of getting rich.
And for a sliver of time in the recent past, it unfolded beautifully.
But with a market built upon the pillars of supply and demand in their most pure form, consequences can be swift and harsh if the market moves out of balance, and this time was no exception.
As a gargantuan amount of fresh oil was brought to market and flooded the scene over the last few years, the price of oil plummeted. Oil was over $100 in July of 2014, and by March of 2016 the market was below $30 per barrel as refineries were drowning in excess crude.
Price fell off a cliff. Talk of peak oil crumbled and gave way to an epic oil glut. Record levels of oil were stored. Plummeting price decimated drillers, hampered traders and crippled new projects as the economics became prohibitive with oil at such tepid prices.
And just as important, there were international players that felt marginalized and impacted by the metamorphosis in the US.
With so much happening in America, it had been easy to forget about OPEC and the influence they could exert. Nostalgic for the days when their cartel and its whims were the genesis for world prices, OPEC hatched a plan to construct a more favorable price environment. After all, no matter how much oil flows in the US, oil is always an international affair, and with prices dropping to shockingly low levels, OPEC was not content dwelling on the sidelines.
The ante of lower levels of shale production, due to lower prices, was matched by OPEC with an agreement it reached last year with member nations to limit production. As consumption continued to tick up due to improving global economic growth prospects, the glut was worked down due to marginally more demand coupled with materially less supply.
Reminiscent of an old fashioned puppeteer pulling on his favorite marionettes, the OPEC members and their agreement drew the market in their desired direction. Markets stabilized at balanced levels for producers and consumers, and a relatively easy harmony descended on energy markets as conditions stabilized.
Oil Supply Trends On The Horizon
Over the past few months, as the OPEC agreement seemed to work, crude oil prices continued to drift higher ultimately reaching three-year highs last week.
The irony is, it might have been too much too soon. In a twisted version of be careful what you ask for, OPEC might have helped take price too high. A sustained price above $55 can be seen as an invitation to hungry shale producers anxious to race back onto the scene.
With a recovery in price now firmly established and the price per barrel hovering above $60, a spike in US drilling should commence again, which would make the oil market over the next one to two years all about the shale boom’s triumphant second act.
Over the next decade, according to the US Energy Information Administration, more than 80% of the growth in global supply will come from the United States, and the vast majority of that will come from tight rock formations. If this proves true, the numbers get a bit staggering.
Over the next ten years, if projections manifest, the expansion of oil production in the domestic US will roughly be equivalent to what the Kingdom of Saudi Arabia reached at the height of its epic growth in production through the 1960’s and 70’s according to the International Energy Agency (IEA) in its annual World Energy Outlook.
Shale oil, the force behind what is now possibly the greatest oil boom ever, is transforming America and the world for the foreseeable future.
Where The Shale Oil Boom Goes Next
All of this additional supply from shale, if it plays out as expected, would have a bearish impact on price. How much it impacts price is directly related to how much additional supply hits the market.
The EIA anticipates the US to average 10.3 million barrels per day (b/d) in 2018, up 10% from 2017. If reached, projected 2018 production would be the highest annual average on record, eclipsing the former record of 9.6 million b/d established in 1970.
By November 2019, the EIA says, the U.S. could hit 11 mb/d, surpassing Russia as the world’s largest producer.
With the US as the dominant producer of the world’s oil, this means we could have a radically different oil market in 18 months than we have today. The market of the future would be largely an American one, defined by blinding innovation, exciting speculation, and strategic trading.
Another explosive release of shale oil in the United States could add a level of dynamism to markets. This would allow anyone wanting to participate in oil markets a variety of strategies, including innovative products like binaries and option spreads offered by NADEX (the North American Derivatives Exchange), which allow for traders to pre-define their risk in uncertain and volatile markets, while still gaining exposure to the changes in price of an underlying asset.
With a changing market landscape, using trading products to define risk while still being able to trade the volatility from assets like oil can be a solid strategy for those wanting to participate in the oil markets.
2018 Oil Market Outlook
With such a nimble source of supply coming from the US, our baseline expectation is for current pricing to serve as the apex of a range for 2018. Any lift in prices can be met quickly by US drillers eager to capitalize, and any dip will force them to shut off wells and pause activity. Because of the relatively nimble nature of shale drilling, this type of dynamic management is more possible than it is with some conventional methods, like deepwater drilling, that require significant time and infrastructure to extract crude product.
A range between $55 and $65 per barrel through 2018 is well supported under this scenario but will be subject to the risk and volatility that unpredictable geopolitical events can offer a market.
This new range bound environment will require traders to seek out innovative strategies, while still also allowing them to hedge the risks of unpredictable geopolitical factors. The binaries and option spreads, like those offered by NADEX, can be ideal products for those trading in uncertain markets who wish to define and cap risk as they enter a trade.
This could be a good way to approach trading the oil market of the future, as it takes shape today, in America and beyond.
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