Center for Energy Studies | Research Paper

Energy Market Cycles

August 20, 2013

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The past several decades have been characterized by a repeating pattern of banking, currency and energy-price turning points that have yielded dramatic change. These critical events have created new challenges for energy companies as the industry environment has been altered considerably with each phase of the oil price cycle. Comparing past oil market disruptions to the latest 2007-2009 oil and financial market crisis can provide new lessons for policy makers and corporate leaders about how to ameliorate the effects of future market fluctuations on corporate performance, U.S. national security and world economic growth and development.

In past cycles, oil demand growth has not rapidly returned to the pace of growth seen prior to the period of large price fluctuations. This reality, coupled with the long lead times and large fixed costs associated with oil infrastructure development, has led to a repeating cycle of industry overcapacity that is once again being seen in downstream refining and U.S. natural gas businesses as well as in other aspects of the energy industry. Periods of high prices tend to stimulate new investments in high cost resource plays and other energy assets, but this is generally followed by cost reductions based on technological innovation and relaxation of constraints on inputs. The substantial rise in natural gas prices in North America through 2008 – the most recent example – ushered in a dramatic increase in U.S. domestic natural gas production from shale resources.

At the same time, energy-price shocks usher in new energy efficiency gains and technological advancements through market forces and through a greater inclination towards political and regulatory intervention from governments. This trend is especially pronounced in the United States but is also increasingly becoming part of the landscape in major growth markets such as China. New regulations will impact the operating environment for oil and gas companies in the years to come.

Research Plan

Under this study, the Baker Institute will embark on a comprehensive study on the interaction of the oil investment cycle and the general business cycle, including consideration of how the global economy and patterns of industry capital investment are influenced by oil price shocks.

The specific aims of the study are defined as follows:
(i) To improve understanding of how the business cycle and oil capital investment cycle impact commodity pricing and demand patterns.
(ii) To develop and improve forecasting techniques and tools to inform capital spending and M&A decision-making for corporate leaders in light of cyclicality.
(iii) To provide improved insights into the global price formation process, including analysis of the role of speculators, OPEC and capital spending trends.
(iv) To analyze how government policies and new regulations currently under adoption in key energy consuming economies in the aftermath of the 2007-2008 oil price spike will impact long-term demand trends and competition of fuels.
(v) To analyze to what extent China’s recent increased presence in global energy markets in the 2000s has influenced the commodity and investment cycle.