Last year, OPEC and non-OPEC members agreed to production cuts, which spurred a rise in oil prices that stabilized around $50 per barrel. As a result, US energy companies saw first quarter earnings jump over 600% from last year, which helped S&P 500 earnings grow 15.4%.
Oil has recently fallen to $45/barrel, the low end of our forecasted range (read here), due to (as predicted) an increase in US production. US crude production is already surpassing forecasts for 2017. In late 2016, the US Energy Information Administration estimated that the US would produce 8.7 million barrels per day. New estimates however, expect production to climb to 9.2 million barrels per day in 2017 and 10 million per day in 2018. The US is currently among the top three oil producers. The US lifted the ban on exporting oil in 2015 and now exports about 1 million barrels of oil per day. This means US producers are gaining market share and taking customers away from OPEC and non-OPEC producers (e.g. Saudi Arabia and Russia).
Saudi Arabia’s original goal with letting prices drop was to squeeze US producers. The Saudis had let production run, which cut oil prices to a low of $27 per barrel, making it unprofitable for US producers and forcing them out of the market. Once that worked, OPEC and non-OPEC members agreed to cut production, thereby reducing supply and raising prices. But because of advances in technology, US shale producers are now able to make a profit with oil at $50, leading them to bring their operations back on line. This leaves OPEC and non-OPEC producers in a dilemma. Letting US producers determine supply, and thereby controlling prices, will keep oil below the price OPEC and non-OPEC producers need to finance their budgets and further erode their market share. However, cutting production further to increase prices will reduce their market share even more quickly. On the other hand, increasing supply, to lower prices, to again drive out US production will once more produce the same disastrous effects on their economies.
A lot has changed since the 1970s. Then the US was much more dependent on oil imports and OPEC could control prices. Now the US produces significantly more than it imports, giving US producers considerable influence in the oil market. To manipulate prices, OPEC and non-OPEC producers will have to change production meaningfully which will generate negative consequences for them either way. Recent activity shows that the US has become the “swing player” we predicted. We expect this development to last for the foreseeable future.
Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.
Rick Cloutier, CFA is the Chief Investment Strategist for Washington Trust Bank with over 25 years of portfolio management and investment experience. He is responsible for directing the portfolio management, research, and trading activities for the bank’s multi-asset class strategies. He is also responsible for overseeing the client portfolio manager team and portfolio analytics team. Rick has written numerous articles for Investopedia and wrote a weekly column for the Fall River Herald News in Massachusetts. His research has appeared in numerous journals, including the Journal of Investment Management and Financial Innovations, the Journal of Business Management and Economics, and the International Journal of Revenue Management. He provided a nightly commentary on WALE radio and authored the novel Caveat Emptor. Rick earned his MBA at Boston University.