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Page added on August 2, 2016

Which Way Is Oil Going?

Crude oil prices dropped on Monday, dipping below the $40 a barrel mark for the first time since April. Weeks of slow decline precipitated this 4% loss, which many are blaming on poor earnings from ExxonMobil XOM +0.93% and Chevron CVX +0.13%. The truth is that for most of the summer oil has been overpriced. The global crude oil glut is not resolving and has been joined by a gasoline glut, which, to the delight of American consumers, is pushing gasoline prices down across the nation.

Why were we tricked into thinking the worst of the oil glut was over? Production disruptions in Nigeria, Canada, Libya and Venezuela took hundreds of thousands of barrels out of the market for weeks at a time this spring. In the old market of oil – say in 2013 – this would have raised concerns about shortages. In the 2016 market, however, these disruptions were easily covered by stored oil and production increases in Saudi Arabia, Iran, Russia and the United States. Now that the disruptions are over and the market is finally coming to terms with how much oil is still out there, we are seeing the price correction down.

Some additional factors weighing on the price of oil include the following:

Fracking: Shale oil companies in the United States that made it through the $30 oil period earlier this year are well financed to keep producing – even if oil remains below $50 a barrel. These companies have secure loans from banks and are employing more strategic methods to tap only the cheapest and easiest oil to drill. The number of rigs opened in the U.S. has grown for five straight weeks. Increasing oil production will keep prices from rising, and it probably will not drop prices quite enough to force these companies to stop production.

Speculation: Bets by hedge funds and other speculators helped magnify the price drop. Most fund managers believe the oil market will continue to drop, at least in the short term. So convinced are they, that news that ISIS bombed an Iraqi oilfield in Kirkuk yesterday did not even cause a noticeable blip in oil’s fall.

A picture taken with a mobile phone shows smoke billowing from oil silos following an attack by militants on a gas facility and the nearby Bai Hassan oil field in Iraq’s northern Kirkuk province on July 31, 2016.Gunmen travelling on motorbikes opened fire on the gas facility’s guards, then killed four of its employees and planted multiple bombs before escaping, officials from Iraq’s North Oil Company and the Kurdish peshmerga forces said. / AFP / STRINGER (Photo credit should read STRINGER/AFP/Getty Images)

Iran: Iranian oil exports climbed steadily through June. Iran also offered huge discounts to its customers. The Iranian effect contributed to the current drop in oil prices. It seems that Iran’s exports are now leveling off at just shy of four million barrels a day, so Iran may have reached its exporting limit. That would mean the Iranian effect would not drag oil prices much lower. However, Iran’s general untrustworthiness makes it difficult to know exactly what is going on with their oil industry.

Saudi Arabia: Saudi Arabia recently increased its oil production and cut the price of its oil exports to Asia. Usually, in the summer months Saudi Arabia and oil-producing Gulf neighbors divert huge amounts of their production to domestic uses to power air conditioners and other electric needs. Unlike most other countries, Saudi Arabia uses oil to produce much of its electricity. However, this year, despite the record heat, Saudi Arabia has increased production to keep pace with both domestic electricity use and growing exports to Asia.

Ellen R. Wald, Ph.D. is a historian and scholar of the energy industry. She writes and consults on the intersection of geopolitics and energy.

Forbes