“Lower for Longer” was right and yet so wrong… Finding the real cost of the marginal barrel.

The Marginal Barrel and why does it matter?

The price of the “marginal barrel” in the world of oil is critical, as it dictates the price of all oil. The marginal barrel is the one (or at least a small number of barrels) that represents the gap between supply and demand. In a market that uses c. 100 million barrels of oil per day, the delta between supply and demand is typically only about 1% or 1mmbbls/day. In normal times the price bounces around within manageable ranges as this ebbs and flows. Price has no correlation to absolute supply (see image in title).

Price shocks occur when the deficit or surplus becomes larger. For example, in 2014 the oil price crashed from over $100/bbl to about $50/bbl before continuing south through 2015 because the US shale patch was adding about 1 mmbbls/d each year from 2012 onwards. Disruptions in conventional supply (Nigeria, Venezuela and Libya) left a gap in supply that was almost perfectly matched. However, when Libya brought back on-stream 1.4 mmbbls/day the market flipped into clear over-supply and the price tanked.

Obviously the 30% collapse in daily demand seen in 1Q 2020 due to Covid is and extreme example of this but is such an outlier it is better to focus on normal dynamics.

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