Oil industry demand for trucks; stable fuel prices; economic growth
A new normal range for pricing? JP Morgan forecasts rise to $78 then decline to $60 by EOY
Brent crude oil closed above $70 last week for the first time since 2014, and in January so far, its price has risen 6.3%—the largest January rise since 2013. Last Friday the Baker Hughes Rig Count registered 11 new rigs operating in the United States since the previous week for a total of 947 rigs, up 235 rigs year over year. The United States is projected to produce more oil in 2018 than any other year in its history.
Those two statistics—price and production—have profound implications for the American trucking industry. Oil prices have an obvious importance to the petroleum-dependent transportation sector: high fuel costs make manufacturing and shipping costs go up and retail goods more expensive, depressing consumer demand and all other economic activity with it. Petroleum production, on the other hand, is correlated with demand for truckload miles: trucks haul workers, equipment, water, and frac sand to rigs, and haul oil and gasoline once it is extracted and refined. According to Sam Tibbs, each new oil rig is associated with a demand for nearly 1M truckload miles per year. FreightWaves has reported on the driver shortage in the Permian basin and its potential threat to the oil boom.
Price and production, moreover, are related in complex ways. When in 2015 the U.S. Congress voted to end the 40 year old ban on American oil exports, the legislators were hoping to increase the international market for the light, sweet crude coming out of our shale deposits, give American refineries greater access to a wider variety of oil and increase their efficiency, and make the entire global oil trade more efficient by establishing West Texas Intermediate (WTI) a global benchmark to rival Brent. For many years, OPEC’s cartel and the prohibition on American exports had distorted the global oil market, and that was going to change.
The result has been an overturning of the world petroleum order. The United States became the second-largest producer of petroleum, passing Saudi Arabia and trailing only Russia, and one of the world’s major exporters. The American oil boom caught OPEC and Russia off guard. “This is a 180-degree turn for the United States and the impacts are being felt around the world,” said Daniel Yergin, an economic historian. “This not only contributes to U.S. energy security but also contributes to world energy security by bringing new supplies to the world.”
At first, OPEC and Russia tried to undercut the American shale oil boom by not matching the new supply with production cuts of their own; by allowing absolute supply to continue rising, OPEC hoped that oil prices would drop low enough to force shale oil producers out of business. American exploration dropped and many smaller companies went out of business, but the survivors turned to sophisticated strategies to mitigate their exposure. Shale producers used innovative new drilling technologies, robots, and sensors to maximize output and reduce costs, dropping their break-even point from $70 a barrel to $50. The oil outfits lengthened horizontal wells to find more oil and hedged against falling crude prices to limit their exposure to the market.
With prices below $40 a barrel, petroleum-based economies were feeling the pain, and in 2016 OPEC and Russia changed strategies. Now they started cutting production, limiting supply, and driving the price up. Because the Americans had weathered the first threat, the danger became an over-supply of oil that would cripple countries like Saudi Arabia and Russia before the U.S. was ever affected. The Gulf States needed money, and Saudi Arabia wants to take its state oil company Aramco public, so they cut production to raise prices and valuations. It worked—sort of. American production expanded rapidly to fill the gap and while prices recovered to a healthy level, oil never got expensive. America’s entry into the global market has ultimately been a stabilizing force: the goal is to keep prices high enough to make money for American producers while keeping it low enough for American consumers, to import less and export more.
Now we’re seeing a new order in the global oil market emerge: a Saudi Arabia-led OPEC establishes the floor on oil prices, while American production capacity creates the price ceiling. Oil’s range-bound stability should reduce volatility in fuel prices, while a healthy domestic oil industry consumes millions of truckload miles and stimulates the wider economy. JP Morgan’s senior oil strategist Abhishek Deshpande today raised the bank’s 2018 Brent crude price target to $70 after raising it to $60 on December 20th. Deshpande previously stated that the new tax reform provision for 100 percent capital expenditure expensing will likely translate to more drilling by U.S. companies, as long as the price of oil stays above $50.
Could the price of oil get so high that it negatively impacts world GDP? “A negative supply shock of similar magnitude to this year’s could push prices up a further 20pc and shave 0.5 percentage points off of global growth,” said JP Morgan economist Bruce Kasman. But rising consumer confidence, low unemployment, and rising wages in the United States should form strong enough tailwinds to the national economy to keep higher fuel prices from negatively impacting consumer demand. For his part, Deshpande thinks that the price of Brent crude could rise to $78 by the end of the first quarter, but then decline to $60 by EOY, potentially representing a ‘new normal’ price range established by the new American-led order.
One important oil market metric to keep an eye on for 2018 is the Brent-WTI spread, which is the price of a barrel of Brent crude minus the price of a barrel of West Texas Intermediate. A large positive spread means there’s a substantial discount for American (WTI) oil, which will encourage exports; a small positive spread or a negative spread means that there will be little incentive to export American oil to other countries. During 2017, which saw huge growth in American oil exports, the Brent-WTI spread averaged more than $3.33 per barrel; in 2016, the average price difference was less than $1 per barrel. As long as that spread stays wide, and the price per barrel for WTI is above $50, American production and exports should continue to grow.
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