This reduction has highlighted the impact that the US oil inventories have on world crude oil prices, particularly given the ongoing concerns over a global glut in supply.
The market had risen to the $55/barrel level, gaining around $10/barrel, at the end of 2016 in expectation of a drop in global crude oil supplies. Concerns regarding market oversupply have been strong for the last few years. This led to OPEC announcing at the end of November 2016 that it would be cutting its output in order to support prices. OPEC’s drop in oil production was set to begin in January 2017. The expectation of a fall in supplies led many traders in the market to take long-positions, effectively betting that prices would rise in the future, which supported prices. Reports earlier this year that OPEC members were complying with the production cut underpinned the higher prices.
American oil inventories have jumped over 60% since the start of 2014, helped by shale oil production boosting domestic production. This was despite the sharp drop in US Rig Counts – a measure for new oil and gas production – during 2015 and most of 2016. US production did slow at this point, by around 10%, but this was much less than the 55% drop in the Rig Count which followed the price of oil dropping below $45/barrel. If the Rig Count had stayed low, and existing production matured, then the drop in US oil production may have ultimately been larger. However, as oil prices have recovered so has production. The Rig Count has also increased, showing renewed interest in new oil fields.
Part of the reason why production was being maintained could well have been the falling cost of production. Output can continue, even if oil prices are lower, as profits can still be secured. US shale has helped boost the country’s energy reserves, and the costs of production have dropped as the technology has matured. Reports suggest that the costs for some projects at the well-head have roughly halved since 2014. The gains have now left overall stocks at all-time record highs.
The rising stocks in the US left many wondering if the OPEC production cut would ultimately reduce the global oversupply as planned. In addition, it is uncertain if OPEC’s compliance with its production cuts will be maintained.
The correction in crude oil prices was sharp. Where it goes from here will likely be influenced by further fluctuations in US oil stocks and to what degree OPEC ultimately cuts its oil output.