LONDON: Promises by US shale producers to pursue a more restrictive approach to capital investment and production seem to have emboldened Saudi Arabia and its allies in OPEC+ to test the room for higher oil prices.
If shale firms respond to higher prices and revenues by returning capital to lenders and investors, rather than increasing output, there may be an opportunity for OPEC+ to let prices rise without losing market share.
“Drill, baby, drill is gone for ever. Shale companies are now more focused on dividends,” the Saudi energy minister said in an interview on March 4.
“It’s the shale companies which are themselves changing. They have had their fair share of adventure and now they are listening to the call of their shareholders.”
The kingdom’s interest in testing support for higher prices comes when many investors are expecting a strong upward cycle, or even supercycle, in oil and other commodity prices. Strong economic growth after the COVID-19 pandemic, coupled with expansionary fiscal and monetary policies, is expected to accelerate consumption growth for oil and other commodities.
At the same time, production of oil and other commodities will be constrained by lack of investment during the price slump in 2020 and early 2021 as well as the newfound enthusiasm for “capital discipline”.
In the case of oil, some analysts are forecasting one last supercycle over the next few years before widespread deployment of electric vehicles in the late 2020s and through the 2030s starts to hit consumption.
Bond investors, too, are anticipating a period of above-average inflation, if not a commodity supercycle, as governments and central banks try to reverse employment and income losses stemming from the epidemic.
Yields for US Treasury Inflation-Protected Securities imply traders expect an average all-items US inflation rate of about 2.2% over the next decade.
Expected 10-year inflation rates peaked at 2.25-2.5% during the 2007/08 commodity supercycle and a similar level during the period of high oil prices from 2011 through 2014.
By comparison, realised consumer price inflation in the United States has averaged about 1.75% per year over the past decade.
The cyclical upswing in oil prices raises several questions. Will it continue? Will it become part of a supercycle? And how will consumers and policymakers respond?
Over the past five decades, there have been three long-lasting spikes in oil prices - in 1973/74, 1979/80 and 2007/08 - with all of them sufficiently significant to be termed “oil shocks”.
Each shock also coincided with a severe business cycle downturn, though the direction of causality remains fiercely disputed by economists.
In each case, there was a permanent loss of consumption as a result of the accompanying recessions, as well as increased energy efficiency and a switch to cheaper sources of energy.
Each shock moved global consumption to a new, lower trajectory, from where it never recovered to the pre-shock path (https://tmsnrt.rs/3qwihoI).
In the five years from 1974 to 1978, global consumption was reduced by about 22 billion barrels from the pre-1973 path.
Five-year consumption losses after the 1979/80 and 2007/08 price shocks amounted to 21 billion and 9 billion barrels respectively.
If oil consumption had continued growing at its pre-1973 trend, consumption would have reached 80.4 million barrels per day (bpd) by 1978.
Instead, actual consumption in 1978 was just 62.9 million bpd and did not reach 80.4 million bpd until 2004.