Why are oil prices so high?
A lot has gone wrong
Oil prices are giving observers vertigo.
They had plateaued for several years, after plummeting in 2014. But for several months now, oil prices have been climbing again. They're not back to their pre-2014 level, but oil prices hit a multi-year high on Monday, just below $79 a barrel. Morgan Stanley expects international prices to hit $85 a barrel in the second half of 2018, which is $7.50 higher than their previous projection.
Just what is powering oil's skyrocketing prices?
It's a few different things, all of which have combined to cut global oil supplies relative to demand.
There's an ongoing conflict in Libya, which has shut down major ports. That's knocked about 850,000 barrels a day out of the global oil market. Venezuela's economy is suffering an absolutely brutal crisis, which has reduced the output of one of the world's biggest oil exporters. Then there's President Trump, who took the U.S. out of the Iran nuclear deal. That means U.S. sanctions will soon be re-imposed on Iranian exports, which could keep as much as half of the country's oil in the ground. Since a lot of oil trading is done with an eye to the future, contracts are already building the coming supply constriction into the price.
Of course, there's also the Organization of the Petroleum Exporting Countries (OPEC), a group of nations who often take a much more state-run approach to their oil production. Many of them, like Saudi Arabia, rely on oil exports to finance their government budgets. That gives them a pretty serious policy incentive to manage the global oil price: If it gets too low, it can undermine their domestic fiscal policies. And after 2014's precipitous collapse, various OPEC countries wound back production to lower supply and drive the price back up.
There's also a wild card here, namely domestic U.S. production.
One of the big drivers of the 2014 price collapse was the unexpected technological arrival of shale oil drilling. That drove a massive American boom in production and a supply glut on the global market. The U.S. government, like most other advanced Western economies, takes a more market-friendly approach to oil production and doesn't try to manage it with an eye to maintaining a particular price.
In decades past, OPEC's strategy for managing the global oil price was partially based on oil production being a slow-moving beast that takes awhile to get going. That meant a big lag time between OPEC's own decisions and responses from market-based production in other parts of the world. The U.S. shale oil revolution was supposed to upend that, creating more advanced drilling systems that could be brought online very rapidly to bring in fresh production. Many observers had predicted global oil prices would struggle to top $60 a barrel for this exact reason. But in practice, switching U.S. production back on has proven tougher than anticipated.
On the flip side, no one wants the price of oil to get too high.
Sure, if OPEC countries let the price drop too much, they can't fund their governments. But if they let it go too high, they scare off demand and drive a bigger response from market-based producers, losing control of the very supply they're trying to manage. Western oil suppliers keep 90 days worth of reserve oil supplies on hand, but they generally only use them in emergencies. Countries like Saudi Arabia, Kuwait, Russia, and the United Arab Emirates also have big reserves on hand, and are much more willing to use those reserves for everyday price management. They may well open the spigots to stabilize prices. The Saudis even began increasing production again three months ago in an effort to cool off the price spike.
And what of President Trump? Heedless of his own role in raising prices, Trump has gone after Saudi Arabia and other countries. "Looks like OPEC is at it again," Trump tweeted in April. "Oil prices are artificially Very High! No good and will not be accepted!"
The Saudis want a cozier relationship with this White House than with previous administrations. They might make an extra effort to control the price to stay in Trump's good graces. On the other hand, now that he's made his decision on the Iran deal, it's not obvious what other policy leverage Trump has. And signals from Saudi Arabia have been mixed: A few months ago, reports were saying Saudi officials would be comfortable with the price hitting $100 a barrel.
Of course, all this assumes that the Saudis or anyone else can control the price. They're more willing to make use of their reserves, but even they can only drain those reserves so much. Like I said, the world has changed significantly since OPEC's heyday. The state-managed model of Saudi Arabia and its compatriots no longer has the same lock on the global oil supply that it used to. American oil production may be slower to respond than expected, but presumably it will respond. And once it does, it will continue producing so long as the price doesn't get so low that things become unprofitable again.
All of which is a long way of saying it's going to be hard to predict the future. Will oil's skyrocketing trajectory continue? Or will it crash to Earth again? Only time will tell.