The Cyclical Nature of Oil & Gas Prices

Oil Pump

The stunning decline in commodities prices over the past two years, highlighted by a dramatic downturn in the price of oil and natural gas, has left many industry observers wondering when the carnage will end. Oversupply driven by the development of shale oil and natural gas formations in the U.S. and continued strong OPEC production, coupled with the market’s anticipation of Iran’s return to the market, have combined to deliver a mighty blow to energy prices.

For those who have followed the energy markets over an extended period of time, however, the recent price action comes as no surprise. Commodities in general and energy in particular tend to exhibit cyclical price behavior. The following pattern has been repeated a number of times:

  • A strong economy creates growing demand for energy causing prices to rise; price increases coupled with easy access to credit lead to increased production.
  • Eventually the economy slows and/or credit tightens and/or new technology or new resource discoveries lead to oversupplied markets, driving prices down.
  • As prices fall exploration projects are put on the shelf, some producers go bankrupt and supply eventually declines.
  • At this point, prices stabilize and then begin to rise as economic growth returns and/or low supply begins to affect prices.

The short version of the above process is expressed thusly: the cure for high prices is high prices and the cure for low prices is low prices.

What is Different About This Cycle?

While the general dynamics of the energy price cycle are well understood, the specific circumstances that accompany a particular phase of rising and then declining prices differ from period to period. For instance, the devastating decline in oil prices in the 1980s was driven by, among other things, the discovery and exploitation of massive new fields in places such as the North Sea and Alaska. The current decline has been attributed, at least partly, to the tremendous influx of supply in the U.S. due to technological innovation, which has enabled production from previously unreachable shale formations.

Magazine Issue 2 Cover
The full article, by Mark Tygart, is available in Issue 3 of Shale Gas International Magazine and can be found on page 29.

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