Donald Trump has decided – well, perhaps announced as a prelude to the Art of the Deal – to renounce the Iran nuclear deal and this has made the oil price spike up to $77. The important point to note here is that this is a spike. It may get worse, that’s always possible, but it’s not going to be a long term issue. We’re simply not going to return to oil at something above $100 a barrel for any great length of time. The reason is technological – fracking means that oil just isn’t as it used to be.
More than 12 hours after President Donald Trump announced the US would be pulling out of the nuclear deal with Iran and reimposing sanctions on the country, the oil price has shot to its highest in more than three years. But the reaction in futures contracts was more subdued than in the spot market.
A reasonable suspicion would be that the longer the futures contract the less the spike:
Brent crude is continuing to rise, and just hit $77.20 per barrel for the first time since November 2014.
One of the most difficult things for any of us is to realise when that world out there has changed. Habits get formed, ways of thinking about reality become embedded, then when that world beyond the window alters we still end up applying the old rules. It’s for this reason that science is said to advance one death at a time.
Here it’s with oil, fracking makes all the difference.
Time was that a new oil field took a couple of decades to bring into production and then produced for several decades more. Development costs were very high, meaning that once open you kept pumping from the field. The short term demand for oil is inelastic and that medium term inelasticity of supply meant that we could and did have wild price swings which could persist for many years.
Enter fracking. In an area which is even vaguely set up for the technique it takes a few months to bring a new well into production. That well might produce for 18 months or so at any rate. It’s also pretty cheap – $10 million should do it. This means that fracking has led to much greater elasticity of supply. Price goes up substantially and hundreds or thousands of wells might be spudded. It falls and no new ones are, production falling off rapidly from those that are currently producing.
We thus got a restriction on the upside (and, logically, the downside) of the oil price – don’t forget that in a fungible commodity like oil the global price is set by the marginal barrel. Exactly where that limit is will be an interesting question but that it is there isn’t in doubt. We’re not going to get substantially above $100 for more than a few months simply because such prices would lead to a stampede of new fracking wells. You know, given that many of them are in profit at above $60 and it does only take those few months to get new ones going.