Conventional wisdom in the fleet market is often wrong. If we roll back the calendar to 10 years ago, the conventional wisdom about future fuel prices was that there would be ebbs and flows in price per gallon rates, but the overall price trajectory would trend upward. The flaw with conventional wisdom is that it only works when no new variables are inserted into future projections.
A case in point is the shale oil revolution, which now has experts predicting oil prices will remain flat for the foreseeable future, perhaps much longer than any of us anticipate. Who predicted this 10 years ago? This forecast of flat fuel prices has positive ramifications for the fleet industry, as it will impact not only fuel prices, but also the cost of replacement tires, plastic-based auto parts, and tangentially, even the types of vehicles offered on fleet selectors.
Growth of U.S. Shale Oil Production
Currently, global oil production exceeds global demand, which is putting downward pressure on fuel prices. What is contributing significantly to this glut in global oil inventory is the dramatic resurgence in shale oil production in the U.S., which has increased to 5.5 million barrels a day, according to the U.S. Energy Information Administration (EIA). The EIA forecasts U.S. crude oil supply will grow almost 5% in calendar-year 2017 and again in 2018 by nearly 8%. The U.S. is on track to surpass Saudi Arabia as the No. 1 oil exporting nation in the world.
Although ongoing economic growth in China and India will increase global fuel consumption to a record 100 million barrels per day in the second half of CY-2017, this increase in global demand is still below the growth in the global production of crude oil. For comparison, global consumption of oil in 2018 is forecast to increase by 1.4 million barrels per day; however, non-OPEC production is set to increase by 1.5 million barrels a day. Despite growing global consumption, global production will continue to exceed demand. This has a direct correlation to price. Overall, oil prices are down 17% since the start of CY-2017 and there is nothing on the horizon to indicate this will change in CY-2018.
Today’s supply/demand dynamics for crude oil are not unique. There is precedent for today’s situation when the new production of North Sea oil ramped up in the late 1980s, exerting downward pressure on oil prices. This persisted for 20 years until the emergence of the Chinese economy. The spectacular growth of the modern Chinese economy was the catalyst causing global demand for oil to exceed inventory, which put upward pressure on fuel prices as demand exceeded supply. But this equation changed when U.S. shale oil production ramped up. In fact, future oil prices will increasingly be influenced by the cost to produce U.S. shale oil and less so by OPEC.
The collapse of the oil shale industry in 2014 when Saudi Arabia depressed prices by substantially increasing production turned out to be a blessing in disguise. When the price of oil fell below the cost to produce shale oil, the U.S. industry was forced to cut costs by learning to extract oil with less gear and smaller work crews.
In addition, there have been advances in fracking technology, such as hydraulic fracturing closer to the wellbore versus the massive, more expensive, wide-ranging fracks of the past. Today, U.S. producers are able to operate profitably at lower crude prices, which promises to keep prices low; since higher crude oil prices would only stimulate greater U.S. shale oil production. In June, Wells Fargo forecast that the price per barrel of crude oil will fluctuate between $30 and $60 in the coming years. Likewise, Goldman Sachs forecast oil prices will be $53 to $56 per barrel of crude oil, depending on the index used.
Another example of surging shale production, is that the total rig count in the U.S. increased to 741 rigs in June 2017 compared to 328 rigs one year earlier. In 2017, the big integrated oil companies, ExxonMobil, Chevron, and Royal Dutch Shell announced $10 billion in combined spending on U.S. shale projects. The EIA now forecasts that U.S. crude oil production (all oil production including shale oil) will surpass 10 million barrels per day in CY-2018, a new record high. The old record was set in 1970 at 9.63 million barrels per day.
Can the U.S. Join OPEC?
An interesting question is whether the U.S. would ever become a member of the Organization of Petroleum Exporting Countries (OPEC), but this is unlikely for a number of reasons. First, countries seeking membership in OPEC must have a “substantial net export of crude oil” and “fundamentally similar interests” to the current members. To become a member of OPEC, a country must receive approval from three-quarters of the existing members and all of the founding members, two of which are Iran and Venezuela, which are currently not on the best of terms with the U.S.
While the U.S. is indeed a major exporter of crude oil, our national interests are not “fundamentally similar” to other OPEC countries. Second, the U.S. would have difficulty complying with OPEC rules, which seeks to influence oil prices by how much each member produces annually. There is no legal mechanism in the U.S. that allows the federal government to control domestic oil production. In addition, the U.S. has specific anti-trust laws against collaboration by producers in the same industry to determine the minimum price of a commodity.
Where in the past, Saudi Arabia was the “swing producer” that could influence the price of crude oil, today, the U.S. is emerging as the new swing producer that can influence the global price of oil based on our domestic production of shale oil.
Hopefully, I’m not a purveyor of new “conventional wisdom” by making this assertion.
Let me know what you think.