Comments: Volatility Trumps Stability
Authors: Donnelly John 
Published: August 2017

Editor's column

Last month, OPEC received another warning that the battle for market share in the global oil market was not over. “It’s not beneficial for OPEC to deepen their cuts because prices will go up and shale oil producers and others will take OPEC’s market share,” Abdullah al-Attiyad, the former oil minister of Qatar, said in an interview with the Bloomberg news agency. “The problem is that there is someone waiting in the dark corner for OPEC—it’s shale oil producers and whenever prices rise, they raise production.”

Al-Attiyad’s remarks came after the International Energy Agency reported that the oil market was not balancing as quickly this year as some had predicted. OPEC output rose to its highest level of the year in June and its compliance with production cuts slumped to 68%. Meanwhile, oil prices meander in the USD 45–50/bbl range and remain under pressure as US production remains strong.

The oil market has historically been an interplay between supply and demand. But a new book by a consultant and former top energy adviser to US President George W. Bush argues that oil boom-and-bust cycles are here to stay and will likely be more volatile than those in the past. Periods such as from 2004 to 2008—when oil rose to USD 147/bbl and then dropped to USD 33/bbl—or what has happened between June 2014 and the present—prices falling from USD 107/bbl to USD 26/bbl and then back to around USD 50/bbl—could be the new norm. “Recent oil fluctuations mark the return of a new and unfettered market for crude oil and, as a consequence, boom-bust oil prices are making a return after 8 decades,” Robert McNally, who is also a fellow at the Columbia University Center on Global Energy Policy, writes in his new book Crude Volatility.

Contradicting the current general consensus that US shale producers have replaced Saudi Arabia as the market’s swing producer—increasing supply as the market tightens and prices rise, and decreasing production as the market dictates—McNally argues that Saudi Arabia abandoned that stabilizing role in the mid-1980s, except for some occasional tinkering with global oil supplies in the 1990s, and shale producers are not cohesive enough to fill that role. The lack of a true swing producer explains the dramatic ups and downs of oil prices since 1998.

McNally divides oil price history into 5 eras: the severe boom-bust cycles after oil’s discovery in Pennsylvania in the late 1800s; John D. Rockefeller’s Standard Oil monopoly that enriched him but stabilized prices; the return of volatility after the Standard Oil breakup and the discovery of huge quantities of oil in Texas, Venezuela, California, and Mexico beginning in the 1920s; price stabilization by the Texas Railroad Commission from the mid-1930s to 1972; and OPEC’s attempts to control the market. But OPEC has never had sufficient spare production capacity to truly control prices, McNally believes, and non-OPEC discoveries from Alaska to the Gulf of Mexico and elsewhere have undercut the cartel’s attempts.

McNally believes that price swings in the range of USD 30/bbl to USD 100/bbl may be likely, playing havoc with governments that depend on oil revenues and companies trying to plan expensive projects. Oil cycle volatility is caused by basic economics—imbalance in supply and demand, which fuels price swings, which causes further sup-ply fluctuations. And because the industry is often surprised—whether it be the sharp growth in Asian demand in the early 2000s or the recent incredible growth in shale production in the US—it will be impossible to stabilize prices in the short term.