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In just a mere few months, it seems the global oil market has been turned upside down. Oil prices have slid more than 30%: Domestic producers are pushing hard for politicians to lift U.S. crude export restrictions -- or find creative ways around them: Analysts and investors seem more and more concerned that we are entering a period of global oversupply.
There's no light way of putting this, the U.S. broke the global oil market.
Truth is, we probably should have seen it coming. After all, this isn't the first time that the U.S. has recently taken traditional oil and gas market dynamics and thrown them completely on their head. Let's take a look at the last time the U.S. created a massive shift in the global market for these commodities, why this market shift seems eerily similar to the last one, and what it might mean for the future of oil down the road.
"We could break the natural gas market*"
Back in 2008, a few years before the shale boom really took off here in the U.S., Aubrey McClendon -- then CEO of Chesapeake Energy -- said to a friend that his biggest worry about the future of his company wasn't that it would struggle to find enough natural gas. He was worried Chesapeake was finding too much. At the time, it seemed like one of the craziest things a domestic energy executive could fret about.
Sure, a few of the first shale wells were starting to emerge as productive and economical, but that was in large part because natural gas was close to $9.00 per million BTU. The overriding theory was that shale would be a marginal producer at best that needed really high gas prices to work economically.
Then this happened.
US Natural Gas Marketed Production data by YCharts
Just like Mr. McClendon had predicted, the amount of natural gas brought on by shale has been spectacular, and it completely disrupted the market for gas. By 2012, Henry Hub spot prices -- the American benchmark price -- touched epic lows of around $1.80 per million BTU.
So, instead of the nation -- and in some ways, the world -- ramping up to import massive quantities of liquefied natural gas (LNG) to cover demand shortfalls in the U.S., homegrown production overwhelmed the market. Companies with LNG import terminal plans were completely scrapped, and some daring companies such as Cheniere Energy started to explore the possibility of exporting LNG from the U.S. instead.
The impact of this move was felt beyond the U.S. as well. For all that capacity that we were bringing on to import, the rest of the world was building out the infrastructure to export. Now, with all of that export capacity no longer needed for the U.S., the rest of the world has needed to shift its LNG export efforts elsewhere to places such as China and Europe, which now compete with U.S. exporters -- some of the lowest cost supplies in the world -- for supply contracts.
Man, does this feel similar
At about the same time that Aubrey McClendon was worrying that his company was going to contribute to the complete disruption of the natural gas market, most of America was wringing its hands over peak oil and how we were approaching the time where supplies would go into structural decline. Net imports to the U.S. were over 12 million barrels per day, and 45% of them came from OPEC countries. In a few select places across the country, though, a few independents were trying to see if they could replicate the success of natural gas producers in shale formations. This time with oil.
Now fast forward again to today, the production curve for oil is really starting to look familiar.
US Crude Oil Production data by YCharts
The Bakken formation in North Dakota and the Eagle Ford shale in South Texas combined -- two parts of the country that were producing only a couple thousand barrels per day -- now crank out a combined 2.7 million barrels per day. And just like when the U.S. said "no thanks, we got this" to LNG imports, net oil and petroleum product imports have declined by more than 60% to under 5 million barrels per day; pushing the rest back into the global markets for consumption elsewhere.
And just like gas, this has completely disrupted the way that oil moves around the world. Tankers that used to move gasoline to the U.S. in exchange for diesel to Europe are finding that the voyage to the U.S. is with an empty hull. Nigeria, a country that used to supply the U.S. with as much as 1.2 million barrels per day, has seen U.S. bound exports cut greater than 90%. All these extra supplies that used to call the U.S. home are a large reason why we are seeing prices slump now to the lowest they have been in many years.
Before you go and do anything rash ...
When oil prices tumble this quickly, many people will start to panic about what to do next. Well, based on what happened when natural gas prices fell through the floor, you shouldn't worry too much. When natural gas hit such ridiculous lows, producers like Chesapeake started to shift toward oil drilling which slowed natural gas growth. Also, those prices meant an increase in demand, and the market eventually corrected itself to the point that natural gas is now at a more comfortable $4.25 per million BTU.
It's tempting to say "this time it's different," but that train of thought has proven itself wrong time and time again. Evenutally, oil will do the same. It might take longer because oil flows more freely in the global market than gas and large oil projects will be completed in the next couple of years. Eventually, though, wells that aren't productive at today's prices will not be drilled, exploration budgets will be a little smaller for everyone involved, and cheap oil should spur some economic activity and increase demand. It happened back in the 80's when there was an oversupply; it happened again when there were demand shortages in 1999 and 2008; and its highly likely to happen this time around as well.
What a Fool believes
The biggest difference that you and I may have noticed from the boom in U.S. oil production is that it's a little cheaper to fill up at the pump, but this rapid surge in production has global implications that we may not appreciate. Whenever something really drastic like this happens to the price of oil or any other commodity, though, we as investors can get caught thinking its the "new normal" or some other ridiculous statement like that. Even worse, we tend to make rapid investment decisions based on these silly ideas. So, before you make any investment decisions because the U.S. decided to break another commodity market, just remember what happened last time.
And the time before that.
And the time before that.
*Quote from The Frackers: The Outrageous Inside Story About The New Billionaire Wildcatters, by Gregory Zuckerman
