Geologist Arthur Berman explains why today's low oil prices are not here to stay, something investors and consumers alike should be very aware of. The crazy-low prices we're currently experiencing are due to an oversupply created by geopolitics and (historic) easy credit, not by sustainable economics.
And when the worm turns, we are more likely than not to experience a sudden supply shortfall, jolting prices viciously higher. This will be a situation not soon resolved, as the lag time for new production to come on-line will be much longer than the world wants:
The same things that always drive prices in the end it's always about fundamentals. The markets are peculiar and they change every day. But the fundamentals of supply and demand at some point markets come back to those and have to adjust accordingly. Not on a daily basis, maybe not even on a monthly basis. But eventually they get it right. So this oil price collapse is really straight forward as far as I can tell, and it has to do with cheap stupid money because of artificially low interest rates that resulted in over-investment in oil - as well as lots of other commodities that are not in my area of specialty, but that's what I see. And over-investment led to over-production and eventually over-production swamped the market with too much supply and the price has to go down until we work our way through the excess supply.
Now the wrinkle in all of this is that because the supply excess/surplus was generated by debt and a lot of correlative instruments, the problem is that the companies and the countries that are doing all this over-production need to keep generating cash flow so they can service the debt, which means they have to continue producing pretty much at the highest levels they possibly can which doesn't really allow very much room for reducing the surplus. So that's piece number one and then there's the demand side. So the thing that drove all of this over investment and over production were high prices. And after a while people get tired of high prices and we see a phenomenon called demand destruction or you know as Jamie Galbraith calls it the choke chain effect. You know your dog runs out on a leash, eventually you know it stops and he chokes and so we're dealing with that. People have changed their behavior because of high prices and then we add to the fact that people just change their behavior. I mean young people aren't driving as much as they used to, they spend their time in a - you know on a smart phone more than they do in a car. We've got climate change issues. There's considerable momentum toward cutting back on fossil fuels. Add it all together, demand is down, supply is up, it's a bad situation...
We started this conversation with your important observation that we're only talking about a million or million and a half barrels a day of oversupply. So we could go from over-supply to deficit pretty quickly, because we're not investing in finding that additional couple of million barrels a day that we need to be discovering. So we're deferring major, major investments. We're not just deferring exploration; we're deferring development of proven reserves. Capital cuts across the world represent 20 billion barrels of development of known proven reserves. And so we will get to a point, and we will, we most certainly will, where suddenly everybody wakes up and says "Oh my God we don't have enough oil! We're now half million barrels a day low." And what will happen? The price will shoot up. That's the way commodity markets work. And everybody will say "Whoopee! Let's get back to drilling big time." Well there's a big lag. There's a huge time lag between when the price responds and people actually get around to drilling and they actually start bringing the oil onto the market and it becomes available as supply, because they've been asleep at the wheel for you know for how many months or years. And so you know you can't just turn a valve and all of a sudden everything is okay again
Click the play button below to listen to Chris' interview with Arthur Berman (56m:07s)