The Risks Facing Oil Markets Have Changed

At a Glance

  • Roundtable with economists, traders examines the effect of surging U.S. production and geopolitical events in the Middle East
  • The Middle East oil risk premium is a fraction of what it was a decade ago  

The mid-September 2019 drone strike on a Saudi Arabian oil facility and the early January 2020 killing of an Iranian general and retaliation on a U.S. military base in Iraq were both events that caused an abrupt $5-8/barrel increase in the price of oil followed by a quick reversal.  A decade or two ago, these events would have triggered a $20/barrel increase, which would not have dissipated very quickly.

What has changed over the years has been the surge in shale oil production, making the United States the world’s largest oil producer and ramping up U.S. petroleum exports.

Shale producers are active hedgers compared to deep well producers.  Shale wells have an 18-24 month lifespan, and then new wells must be drilled to maintain production.  When prices spike higher, shale producers can be quick sellers of future production, as a hedge for future profits, contributing to the rapid return to the previous pricing structure.

Also, the recent two spikes in oil prices came at a time of relatively high inventories, lessening the price shocks. Longer-term, the amount of new capital expenditures (capex) going into the U.S. shale market is declining, portending a slowing of production growth from the U.S. down the road.

Short-term, the Novel Coronavirus has dampened Chinese growth expectations and hit the price of oil hard.  This is likely to be a temporary factor, reversing once the virus is contained.

Currently, we believe that the Mideast oil risk premium – the extra return vs. a risk-free asset – is about $5-8/barrel.  Those worried about increasing U.S.-Iran tensions, declining inventories, less capex spending, etc., might view this as too low.

If these factors continue to pose risk for the oil markets, that may indeed be the case.

Watch Angie Miles, Jim Iuorio, Blu Putnam and Erik Norland discuss the state of oil market risk in the video above.

Bluford (Blu) Putnam has served as Managing Director and Chief Economist of CME Group since May 2011. He is responsible for leading economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact. Prior to joining CME Group, Putnam gained more than 35 years of experience in the financial services industry with concentrations in central banking, investment research and portfolio management. He has authored five books on international finance.

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