Slowing demand and excess supply have caused the price of oil to crash by more than 30% from their highs of the summer.
Around the world, the cost of drilling oil varies widely. Ultimately, when the price of oil falls below a particular breakeven level, then a drilling project becomes unprofitable and it makes sense for the driller to just shut down the particular project.
However, the world still needs massive amounts of oil. And when prices fall, the world is likely to use more of it.
Unfortunately, drilling projects can’t just be turned on like the flip of a light switch; it takes time. Because tight capacity is likely to cause demand to outpace supply, the price of oil is likely to pick up.
And as prices pick up, those unprofitable drilling projects suddenly become profitable again.
So the saying goes in the commodities market: The cure for low prices is low prices.
Morgan Stanley’s Ole Slorer sums up the whole cycle in this slide:
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