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This article first appeared in Forum, The Edge Malaysia Weekly, on April 4 - April 10, 2016.

 

WATCHING the developments in the oil market is somewhat akin to watching the famous cartoon series, The Road Runner Show.

In this popular Looney Tunes series, crafty Wile E Coyote goes on an endless chase after the fast-moving roadrunner, up and down all sorts of hilly terrain while pulling all kinds of tricks imaginable, before running off a cliff and severely injuring himself.

This is essentially the story of oil prices, which initially surged to a high of over US$100 per barrel between January 2011 and August 2014, propelled by bullish sentiment for both supply and demand.

One can probably still recall that at one point prior to 2014, bullish oil price expectations drove producers to spend billions on cutting-edge technology to extract as much crude oil as possible from any given oilfield. The capital expenditure of major producers expanded tremendously, and “shale production” became the buzzword.

Indeed, supply was widely expected to remain limited as the Organization of Petroleum Exporting Countries’ (Opec) spare capacity declined over the years. By 2012, spare capacity had fallen to roughly two million barrels per day, from over five million per day in 2002. In addition, supplies were often interrupted by geopolitical events that resulted in occasional shocks to the crude oil market.

On the demand side, a rosy picture was painted on the prospects of China’s economy, which now ranks second to the US. Based on Opec’s statistics, China’s crude oil imports, which stood at about 6.2 million barrels per day in 2014 — the second highest after the US — have been a major driver for global crude oil prices.

Accordingly, China’s crude oil imports grew at an astounding compound annual growth rate of 9.6% between 2004 and 2014, accounting for about 15% of the world’s crude oil imports in 2014, up from a mere 6% in 2004. So, how could anybody not be bullish about the future trend of oil prices? Even a major global investment bank is remembered for forecasting oil prices to hit US$200 per barrel at one time.

And so, just as Wile E sped around confidently in his pursuit of the roadrunner, oil traders were convinced about crude oil prices’ upward trajectory for the foreseeable future. And again, just like Wile E’s dream of having the roadrunner on his dinner plate, oil traders were hoping to laugh all the way to the bank after selling increasing amounts of crude oil at ever-increasing prices.

But as we all know, Wile E always forgets about the cliff. In his enthusiasm to capture his favourite bird, Wile E — as we always see in the series — runs off a cliff at the end. Not realising that he is no longer on solid ground, he cycles in the air for a while before plunging to the ground below.

Similarly, oil price movements got too wild at one point, rising exponentially before traders realised that they mirrored the classic “tulip mania” phenomenon. So, the days of reckoning finally came, and after “cycling in the air” for a period of time, oil prices gave in to selling pressure. And this time around, the downfall really looked like those that Wile E experienced — swift and deep.

Suddenly, the world is awash with crude oil that could fill up swimming pools all over the world. 

Genius shale producers who revolutionised oil-extracting technology suddenly found themselves in trouble, trying to recover billions of dollars’ worth of expenditure in past years. Initially, they acted like Wile E, who quickly pulled himself up and dusted himself off, before beginning to run again.

Some shale producers initially managed to slash production costs and kept pumping oil. But some have not been able to live up to Wile E’s normal plot of making a quick comeback to chase the roadrunner. Hence, many threw in the towel, causing the number of active oil rigs in the US to decline dramatically to below 500 early this year, from over 1,500 just 18 months before.

There is now this critical question about the upcoming plot: after plunging precipitously in the past year, will oil prices be able to mirror the common storyline of Wile E, who, after a fall, starts putting together his favourite new Acme-branded weapons and gets ready to chase down the roadrunner again? Will the current 50% recovery in crude oil prices from its cyclical low in February lead to another wild chase towards US$50 to US$60 per barrel?

Many observers are seeing a divergence from the cartoon’s common plot at this juncture. To a lot of them, the damage has been too severe. The story of a global oil glut is far too compelling and much too irresistible to ignore. After all, reports suggest that US storage levels remain near 80-year highs. The storage capacity at the hub of Cushing in Oklahoma is still close to 90% full.

In addition, shale production will resume once crude oil prices start to show signs of a sustainable uptrend. Iran’s prospects of injecting another one million barrels a day remain a real possibility. And of course, China’s weakening economic muscle is one key factor that will ensure that crude oil supply will outstrip demand in the next year or so. Say goodbye to the Wile E plot for now. He won’t have enough energy to chase the roadrunner anymore. Or will he?

Nobody really knows what to expect of the upcoming plot. But a scriptwriter would have to be reminded about a few things at this juncture. First, China’s demand remains encouraging, up 24% year on year in February, fuelled by strong car sales, while India’s crude oil demand — roughly a third of China’s — looks robust. Similarly, demand from the US and Europe is supporting oil prices.

On the supply side, the International Energy Agency  is looking at a reduction of 750,000 barrels per day in global non-Opec production in 2016. The US remains the main source of 2016’s production decline, contracting by 530,000 barrels per day, according to the estimate. Russia is also feeling the strain, hence its production might not be able to match last year’s level.

However, just as Wile E demonstrates in his pursuit of the roadrunner, it will never be a smooth-sailing experience. He will occasionally trip and fall. The road ahead remains bumpy for oil prices, and the hangover from the deep plunge in 2015 will dictate the path going forward.

But just as Wile E always pulls himself up after his fall to start chasing his favourite bird again, the same can be said for oil prices — but at a decidedly slower pace, I would think.


Nor Zahidi Alias is chief economist at Malaysian Rating Corp Bhd. The views expressed here are his own.

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