Oil producers are getting another brutal reminder that theirs is a business characterised by long, deep price cycles.
Benchmark Brent futures have dropped below $90 a barrel, the lowest level since December, 2010, but that actually understates the extent of the damage.
The problem with using December, 2010, as a baseline is that oil prices at the time were hugely distorted by the cyclical downturn in demand caused by the financial crisis and the ensuing recession. Most analysts would agree these effects were temporary and give little insight into long-term oil-market trends.
If the period covered by the recession (late 2008 to early 2011) is excluded to give a more representative picture, the price of Brent has not been this low since February, 2008, when price increases were still accelerating towards their eventual peak five months later.
And if prices are adjusted for inflation (using average U.S. hourly earnings), Brent prices are at the lowest level in real terms since October 2007, exactly seven years ago.
The oil industry has always experienced very long, slow and deep cycles in supply, demand and prices: the current downturn is no exception.
Both the surge in oil supplies and slowdown in demand are the lagged response to the increase in prices which started in 2002 and lasted until 2012, albeit with a hiatus during the recession between 2008 and 2011. It was the stimulus of high and rising prices which made the application of hydraulic fracturing and horizontal drilling possible in the North American shale oil plays.
And it was the panic brought on by rising fuel bills which prompted households, businesses and governments to conserve fuel by turning to energy efficiency and substitutes such as ethanol and natural gas.
Fuel supply and demand are characterised by an enormous amount of economic and technological inertia. It takes many years for a price change to start having a meaningful impact on production and consumption, which is why many of the impacts of the earlier rise in prices are only now beginning to be felt.
For the same reason, however, once those deep-cyclical changes are under way, they are extremely difficult to arrest or reverse. Like a supertanker, changes in supply and demand wrought by price rises in 2002-12 have developed a momentum of their own and cannot easily be stopped.
Just as oil prices had to overshoot in 2008 to overcome the natural inertia in the system and force big increases in supply and reductions in demand, prices will now probably need to over correct on the downside to put the oil market on to a new course.
The existence of this long cycle is confirmed by the fact that each temporary peak in prices since July, 2008, has been lower than the last, which indicates that a gradual shift in both supply and demand have been under way, producing a gradual price downward.
The same unwinding of the supercycle is evident in other commodities, notably the thermal coal market. Benchmark coal prices to Europe exhibit identical behaviour: a massive escalation between 2002 and 2008, followed by the recession, a partial recovery by 2011, and then a gradually falling trend in which each temporary peak is lower than the last. Broadly, similar pricing patterns are evident in other major industrial commodities as diverse as aluminium and copper. The best way to characterise the current fall in oil and other commodity prices is that it is the downswing of a long price cycle that dates from around 2002.
During the upswing, the synchronised rise in the price of many industrial and agricultural commodities was dubbed by analysts as a ‘super-cycle’.
In their excitement, many investors and businesses focused on the ‘super’ and forgot about the ‘cycle’, ignoring the fact that at least some of the increase in prices would eventually need to be reversed.
(The author is a Reuters market analyst. The views expressed are his own)
