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U.S. Shale Revolution & Free-Market Economics Dominate Oil Prices

Olivier Jakob, Financial Times

Back in 2015, we coined the term “shale price band” to describe the economic reality of US crude oil production. Our theory is that the price of US crude in the era of shale oil, will stay in a price band between $40 a barrel and $60 a barrel.

A price move below $40 a barrel will trigger a supply reduction as projects become uneconomic, while a move above $60 a barrel will accelerate the pace of US crude oil production growth to a level that will ultimately crash prices back down to the band in order to temper production.

The US benchmark West Texas Intermediate stayed in the band during 2015, breaking below it in early 2016 only to quickly rebound.

It stayed within the band until early 2018 when the supply cuts of the expanded “Opec+” group finally managed to reduce crude oil stocks and support a true break of the $60 a barrel resistance in WTI.

With that break, some analysts were quick to claim that the “shale price band” was disintegrating and decisively broken and that oil prices would spike to $100 a barrel or above by 2019.

As US crude oil production was not immediately responding to the spike in prices, it was wrongly assumed that supplies were no longer able to keep pace with global demand growth, and that prices would no longer be capped.

Yet, as we approach the end of 2018, the price of WTI has crashed back to our “shale price band”, the crude oil market structure is signalling that supplies are more than ample, and Opec is starting to worry about the return of a prolonged crude oil supply glut.

There are always different factors that influence the price variations of crude oil, but one of the main inputs behind the recent price rout has been the return of much higher than expected US crude oil production.

This time a year ago, Opec forecast that US oil output in 2018 would be 540,000 b/d higher than in 2017.

But in its latest monthly report, it now sees US production rising 1.5m b/d higher than a year ago, matching global demand growth that it calculates at broadly the same level. The shale band has reasserted itself.

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