Wednesday, February 18, 2015

Crude Oil Price: Take Your Pick (excerpt)

There’s quite a debate about the price of a barrel of Brent crude oil. Some experts say it has bottomed and might soon stabilize somewhere above $50 a barrel, but well south of $100. I am not an expert, but agree with this view. Then there are others who say it is going a lot lower.

It’s funny that there wasn’t much of a debate when the price seemed stuck around $110 from 2011 through mid-2014. The supply/demand balance was turning increasingly bearish during this entire period as non-OPEC production surged, led by US output. Yet almost no one expected the sudden plunge in the price that started last October.

The one notable exception was Barron’s, which ran a cover story by Gene Epstein on March 29, 2014 titled, “Here Comes $75 Oil.” That was a great call. However, the article pulled the punch by predicting it could happen over the next five years. It happened over the next 10 months instead, and then some. Gene doubled down with a 12/6 follow-up titled, “The Case for $35 a Barrel Oil.” He did it again in a 1/10 follow-up titled, “Price of Oil: It Could Fall to $20.” The actual analyses are much more nuanced and thoughtful than the titles suggest.

Less nuanced is a 2/16 Bloomberg analysis by my friend A. Gary Shilling titled, “Get Ready for $10 Oil.”  I have been impressed, but not surprised, by the plunge in the oil rig count and expect that it is a harbinger of a sharp drop in US oil production later this year. Gary writes: “Sure, the drilling rig count is falling, but it’s the inefficient rigs that are being idled, not the horizontal rigs that are the backbone of the fracking industry.”

That’s an interesting observation, but it’s hard to imagine that the freefall in the rig count isn’t going to significantly reduce US oil production. Then again, a 2/13 chart highlighted in Bloomberg shows that falling natural gas prices did trigger a drop in the US gas rig count since late 2008, yet US gas production continued to increase: “Why is this happening? For one thing, both the rigs and the oil wells are becoming more productive. Producers are getting better at blasting oil and gas out of the ground. The rigs that are being idled tend to be the older machines, and the most effective rigs are being concentrated on the most-productive oil fields.”

We’ve updated our Global Crude Oil Demand & Supply chart book with January data compiled by Oil Market intelligence (OMI). I have to admit, the picture remained quite bearish for oil prices through the first month of this year:

(1) Global oil demand rose to a record high of 93.1mbd during January, based on the 12-month average. But it was up just 0.8% y/y. Actual global oil supply matched oil demand during January, according to OMI. If that’s anywhere close to accurate, why have oil prices been plunging? The OMI’s supply series tends to be lower than the OMI’s demand series. On a year-over year basis, the former rose 4.6%, while the latter rose just 0.9%.

The ratio of the demand to the supply series, based on their 12-month averages, tends to be a useful indicator of the trend in oil prices. The ratio has been increasingly bearish since the start of last year. In January, it was the lowest since December 1998.

(2) OPEC production has been relatively flat over the past five months through January, and was up 3.3% y/y. Non-OPEC output soared 5.5% y/y to a new record high last month. Interestingly, the sum of US and Canadian oil production exceeded Saudi output by a record 3.4mbd last month.

(3) Fluid situation. Libya’s oil production remains depressed as a result of the country’s chaos, with various militia’s fighting over the oil fields. Egypt might be forced to enter the fray to fight ISIS. On the other hand, Iraqi production continues to rise. Iran’s production could also increase rapidly if a nuclear deal is reached with the US at the end of March. The situation is always fluid in the oil market.

Today's Morning Briefing: Reaching for Zero. (1) Two forces of gravity tugging at bonds. (2) Domestic vs. foreign forces. (3) Fed is the outlier among central banks. (4) Lenders must pay to play. (5) Central banks venture into the underworld. (6) TICS showing inflows into US bonds. (7) The Fed’s chorus and their diva. (8) Running out of patience. (9) The oil debate among debatable experts. (10) Does the rig count count? (11) More than a barrel of excess supply. (12) Ex-Energy, S&P 500 forward earnings is flat at record high. (13) Focus on now overweight-rated S&P 500 Energy. (More for subscribers.)

No comments: