Signs are that the oil price will stay under pressure for years

Even before the pandemic, we were looking at a world where oil demand growth was concentrated in plastics, rather than fuels. That was already darkening the outlook for refiners in Europe and North America, which were also facing growing competition from newer plants in the Middle East and Asia that were more efficient and had beneficial long-term oil supply deals. A prolonged drop in demand will only make that competition stiffer, as more plants seek markets for their excess products.

The upstream part of the business — the bit that’s concerned with finding the crude and getting it out of the ground — may face fewer problems. Oilfields naturally go into decline once they’re brought into operation, requiring producers to create new capacity elsewhere. Nowhere is that more obvious than in the US shale patch.

But the second US shale boom was driven by, among other things, several years of robust growth in global oil demand. This led to most of the world’s oil producers, including almost all of the Opec countries, pumping as hard as they could, and helped to keep oil prices at about $50 a barrel.

But those Opec producers are now cutting production by more than 20%, and non-Opec countries are seeing their output fall by similar percentages. True, some of the wells that get shut will never be reopened, but most will sit waiting for their owners to see an opportunity to get them back to work. That overhang of spare production capacity will put an effective cap on oil prices, just as it did throughout the 1990s.

No amount of Saudi-led supply management or US presidential bullying of foreign oil producers will be able to remove that spare capacity. And once the crisis is past, Riyadh may be less willing to play the role of swing producer, restraining its output while everybody else reopens the taps.

Every time oil prices rise, producers will rush to use their idled capacity, undermining the recovery. After the oil price slump of the mid-1980s, it took two decades for prices to return to their previous levels — longer if you build in the effects of inflation. This time the wait could be even more protracted.

Bloomberg