Oil prices are rising again: What gives?

U.S. Drillers Drove Oil Prices Down. Can They Prop Them Back Up?

U.S. Drillers Drove Oil Prices Down. Can They Prop Them Back Up?

Moneybox
A blog about business and economics.
Feb. 4 2015 2:43 PM

U.S. Drillers Drove Oil Prices Down. Can They Prop Them Back Up?

80864650-car-lights-are-seen-streaking-past-an-oil-rig-extracting
Fewer rigs, less oil.

Photo by David McNew/Getty Images

This week has offered a small glimmer of hope to the world's oil companies and cash-starved petro-states. Yesterday, crude prices hit their highest mark of 2015, having climbed up from a six-year low reached in January. The variety of crude used to set international prices, known as Brent, technically entered a bull market, meaning prices had moved up by more than 20 percent recently. The euphoria was somewhat short-lived—prices are back down a bit today, and a barrel still costs half of what it did in the middle of last year. But nonetheless, it seems conceivable that maybe, just maybe, the market has bottomed out, and that the free fall of the past few months is over.

Jordan Weissmann Jordan Weissmann

Jordan Weissmann is Slate’s senior business and economics correspondent.

If so, that might tell us a little something about America's new and important role in the energy landscape. The globe is still seemingly pumping more oil than it needs. As the Wall Street Journal notes, the U.S. has its largest stockpile of crude in 84 years, and inventories seem to be rising. But traders are feeling optimistic about oil prices because the massive price drop has led to cutbacks in investment by drillers, which should in turn lower production down the line. Companies like BP, Royal Dutch Shell, and ConocoPhillips have all announced that they'll be paring their spending in the coming years. But perhaps more importantly, the number of oil rigs operating in the United States has swiftly plunged, falling 23 percent since October, according to Baker Hughes.

baker_hughes_graph

Jordan Weissmann

Advertisement

In other words, U.S. producers seem to be turning on a dime, reacting to low, low prices by pulling back on their operations.

In the world of oil, this actually is something very new. When companies plunk money into a conventional oil well, they'll usually pump it for years if not decades afterward, even if prices drop, to recoup their investments. That makes it harder for oil supply to fall when there isn't enough demand. But the fracked wells at the heart of the U.S. oil boom are different—they tend to burn bright and die young, producing lots of oil in their first year of life or so, then depleting quickly. As a result, if drillers want to keep production up, they have to keep drilling continuously for new resources. But if prices drop, they can also choose to put their drill bores away, and production can decline naturally.

“The truth is that U.S. shale production can be turned on and off almost immediately, and this represents a dramatic novelty for the oil market,” Leonardo Maugeri of Harvard University’s Belfer Center recently wrote.

This is why some experts, such as oil analyst and Pulitzer Prize–winning author Daniel Yergin, now argue that the U.S. has transformed into the world's new "swing producer"—an extremely important role that has traditionally belonged to Saudi Arabia. When prices rose too high, the Saudi state-owned oil company could ramp up production in order to bring them back down. When they fell too low, it could cut production to send them back up. Their output could theoretically swing whichever way the market needed to prevent a massive boom or bust.  

It hasn't always worked that way in practice. The Saudis triggered a massive oil rout in the 1980s, when they gave up on trying to prop up declining prices, and instead started pumping aggressively to win market share. Last year, history more or less repeated itself. As the glut of oil brought on by U.S. fracking drove prices down, Saudi Arabia chose not to cut back, at which point the cost of a barrel truly started tumbling. In part, the country's oil ministry seemed to believe (correctly) that a price drop now would discourage investment in long-term projects like arctic drilling and set up higher prices down the line. But it also may have been a tacit acknowledgment that pumping less of their own oil would simply encourage American drillers to pump more crude. With prices down, they're instead retreating. America is acting as the swing man.

Or at least, the closest thing the globe has to one. Unlike the Saudis, the U.S. doesn't have a state-owned oil company that it can order to start or stop pumping at will. Instead, it has a horde of small drillers in North Dakota and Texas reacting loosely in concert to market signals. Those companies aren't going to see a price drop coming and collectively try to get ahead of it, which is why, at absolute best, they're putting a floor under prices after an incredible fall. And while America's rig count has been dropping fast, actual production may take some time to follow, since companies are likely shutting down their lowest-yielding wells. In the meantime, the world is still throwing extra oil into storage, which could push the cost of crude down further. So while American drillers might be giving oil sellers some hope this week, it's not clear how long that will last.