Inflation Monitor: Ominous Signals Predict Higher Long Term Oil Prices
Exploration moratoriums, capital expenditure cutbacks, and a growing global disdain of all things carbon will raise oil prices for everyone because demand won’t fall as fast as supply.
Everyone knows what happens when the supply of something falls but the demand for that same something remains – prices generally go higher. Insert crude oil to this simple equation and it’s not difficult to ascertain what the trend for oil prices is likely to be for the next five to ten years.
Three key factors are behind the approaching long term bull market in crude oil: exploration cutbacks will reduce the future supply of oil, infrastructure cutbacks will make it more difficult/expensive to deliver oil that is being produced, and political pressures relating to the production of fossil fuels will raise the cost of oil production at the wellhead.
Natural market forces are largely responsible for the cutbacks in exploration and infrastructure investments. After all, it’s $80 and $100 oil prices that caused a surge in exploration and production through the development of new technologies like fracking; prices went up and so did production. But a global oil industry built upon oil price assumptions well north of $50 a barrel will by necessity contract when oil prices trade well south of the $50 mark. Responsible corporate planners will cut back on future exploration and infrastructure investments when the futures curve suggests oil prices will stay depressed for the next two to five years, which it has been signalling for quite some time now.
In response to this new low oil price environment, production and exploration companies are cutting back on plans for new production, and infrastructure companies are cutting back on expansion plans. As capital expenditures fall across the producing and midstream energy sectors, there will be both less supplies of oil being produced as well as less efficient, and therefore more expensive, modes of distributing oil to end users. All of this means higher prices for oil in the future.
Commodity prices are often cycular; high prices stimulate more production, more production makes prices go down, and then production slows until prices rise again, and the cycle starts anew. If something upsets this natural economic pendulum things could go awry, perhaps setting the stage for higher prices with no corresponding increase in production, which could have enormous implications for consumers. This is the scenario currently unfolding in the oil sector.
Low prices have helped disincentivize new capital expenditures, but political and environmental headwinds are now building that could prevent future increases in capital spending when prices inevitably rise in response to continued growing demand for oil and other carbon based hydrocarbons.
For instance, Denmark has announced an immediate and complete moratorium on all new oil and gas exploration as part of its plan to become a carbon neutral country. The North Sea oil and gas producer will eventually stop producing oil and gas as its current fields are depleted, less in response to market forces but more as part of an intentional, political and environmental agenda that, in fact, will be a major disruptor of the natural supply and demand forces that determine oil prices. Global users of oil and gas are not going to stop using oil and gas at the same rate of the decline in production across the entire global oil exploration sector, which means prices are going to rise.
Like it or not, decisions like those made by Denmark, and perhaps increased regulatory pressure on the energy sector in the United States under a Biden administration, no matter how well intentioned, are going to disrupt the natural economic processes that cause high prices to get rid of high prices. Oil prices are going higher over the long term.
Of course, this is the point, politicians hope that higher prices will discourage the use of fossil fuels and encourage the use of renewables, eventually resulting in a carbon neutral world. While carbon neutrality is a very long term goal that may or may not be achievable, what is virtually certain is that higher oil prices are in the long-term future for consumers around the globe.