What To Make Of the Oil Market Stumble

It’s not just the stock market that tumbled this week. Crude oil prices are down sharply, too. But is this the end of the “epic price rally” that I wrote about two weeks ago?

Benchmark West Texas Intermediate crude has fallen by more than 10% from its Jan. 26th peak of $66 per barrel. Much of that selloff has coincided with the sudden drop in stock prices that began a week ago. This week, when the Dow Jones Industrial Average saw its two biggest single-day point drops in history, WTI came along for the ride.

It might be tempting to assume that oil was simply part of the stock market carnage’s collateral damage. After all, as my colleagues at The Kiplinger Letter write in this week’s issue, “the economy remains on solid footing,” despite the mayhem on Wall Street. The outlook for GDP growth is solid; the economy is creating jobs at a steady clip; and most of the world’s major economies are perking up, too. So, argue the oil bulls, crude prices should bounce back as strong oil demand around the world keeps pushing up prices.

But some supply and demand data paint a less rosy picture for the oil market. For starters, the U.S.’s oil stockpile is growing again as refineries that had been running full-tilt earlier this winter to churn out gasoline and other products have slowed their operations a bit. Bigger stockpiles point to less demand for oil, which is bearish for prices.

More significantly, the U.S. is pumping more oil than ever before. The latest Energy Department data peg U.S. production at a record 10.3 million barrels per day. That vaulted the U.S. past Saudi Arabia as the world’s second-largest crude producer and to within reach of overtaking Russia for the top spot. It is highly likely that America will become the world’s largest producer of crude oil in 2018.

Let that sink in for a moment. Less than 10 years ago, U.S. output, which had been sliding for decades, was about 5 million barrels a day. Production has since doubled and is expanding rapidly. Improved drilling techniques—specifically hydraulic fracturing and horizontal drilling—have powered the turnaround and turned the U.S. into an energy superpower. Texas alone now pumps more crude oil than every OPEC member except Saudi Arabia and Iraq. If North Dakota joined the cartel, it would out-produce half of its membership. Even some lesser-known U.S. oil states, such as New Mexico and Colorado, now dwarf OPEC’s smaller countries. Expect these trends to continue as energy companies put more drilling rigs to work. (Baker Hughes, the oilfield services company, reported a sharp rise in drilling this week, with 26 additional rigs drilling for oil, plus three gas rigs.)

What does this all mean for prices? I expect extremely volatile markets in the near term. Commodities such as oil figure to get buffeted by all the stock-and-bond turmoil. But the long rally in oil that began last summer may be over. If the U.S. keeps stockpiling crude, and if output keeps ticking higher, it will be hard for WTI to surpass that $66-per-barrel peak. I look for a price closer to $60 per barrel this spring, which might be a sweet spot of sorts: High enough to encourage plenty of drilling in the U.S., but not so high that consumers feel a major pinch from rising gasoline prices.