Oil’s New Normal

LAGUNA BEACH – Oil prices have been heading south again, with a barrel of US crude recently falling below $42 – the lowest level since March 2009, the nadir of the global financial crisis. And, while last year’s sharp price drop was heavily influenced by two large supply shocks, the current decline also has an important demand dimension.

At the same time, oil markets are discovering what it is like to operate under the regime of a new swing producer: the United States. As a result, the price formation process is much clumsier nowadays, with considerably longer adjustment lags.

The dynamics of the energy markets changed notably as shale-oil production came onstream at a market-moving scale in 2013-2014. With this new source meeting more of world energy demand, particularly in the US, energy users were no longer as dependent on OPEC and other oil producers. In the process, they also became less vulnerable to geopolitical concerns.

Adding to the supply-side changes was Saudi Arabia’s subsequent historic announcement that it would no longer lead OPEC in playing the role of swing producer. It would no longer lower production when prices fell sharply, and increase output in response to large price surges.