Over the last 14 months Crude Oil prices have fallen more than 60% and are now back at levels not seen since 2004.
The question must be then is the sun setting on the global Oil market or are we about to see the sunrise on a new upward leg for Oil, after these sharp and continuous falls?
Before we can answer this question we should probably just refresh our memories as to how we arrived at the current state of play. And to do that we need transport ourselves to the Austrian capital Vienna on Thanksgiving November 2014 . Which may ultimately be recorded by as one the most momentous days in the history of global energy markets & politics. Because it was at the OPEC meeting of November 2014 that Saudi Arabia threw down the gauntlet to rival producers in a multibillion dollar game of chicken.
The Saudis would quite literally bet everything on black. Believing that by abandoning production controls and any attempt at a price floor for Crude Oil, they could force burgeoning US shale production into bankruptcy and then at some future point, the Saudis and their OPEC partners, would start to ramp up prices and lower production once more.
Chart shows Brent Crude price performance over the last two years.
How's that working out for you?
The first part of the Saudi plan, that is driving oil prices to economically unsustainable levels has certainly panned out. The world is quite literally awash in Oil and the prices of both WTI & Brent Crudes have moved below $30 per barrel (some Canadian benchmarks have traded down to $15.00 per barrel).
However it's possible that Saudis have made a major miscalculation in the second part of their gamble. True the price of Oil has plunged, but even as it has been falling the supply of Crude Oil has been rising and continues to do so. There have been some casualties among US Shale producers but there have also been large new finds in the US Shale beds and it's in the nature of Shale production that these can be and are bought on stream very quickly. Furthermore any US Shale production that has fallen by the wayside has been replaced by offshore production in the Gulf of Mexico.
Russia, Brazil and Venezuela have also been pumping Crude to provide their economies with much needed foreign currency. But supplies have also been building in the Saudis own backyard. This additional supply comes from both Iraq and in the very near future Iran,who, following the Non-Nuclear Proliferation deal are being welcomed back into the global fold. Iran will shortly be able to export Crude Oil once more ,without western sanctions . The Saudi stock market voted with its feet at the weekend on this news , falling by more than 7% ,as the expiration of those sanctions became a reality.
Another flaw in the Saudis planning could be that of Americans politics, the Saudi decision to withdraw production and price controls came just as the US was coming to terms with the idea that it could become self-sufficient in energy and that it could in fact have a surplus of Natural Gas and petroleum products,which it could export to the wider world.
That meant that the US might no longer need to fight ground wars in the Middle East to maintain its exergy security. This is an appealing prospect after two Gulf wars and a decade long engagement in Afghanistan, that, to many American voters appear to have achieved little and cost a fortune in terms of life, limb and taxpayer dollars.
With a presidential election just around the corner, it's highly unlikely that the either a Democratic or Republican candidate would wish to forgo that energy security and the chance to step back from the role of global policemen. At the moment legislation prevents the wholesale export of US Oil and Gas, however these rules are being repealed and the day when tankers leave US ports full of Shale Crude is not far off.
The table shows OPEC Crude production to Nov 2015 and estimates for 2016 production: A two percent gain in supply is forecast Year over Year 2015 /2016.
source Goldman Sachs research
Of course Oil prices are set not only by the level of supply but also by the level of demand. Once again there may be a flaw in the Saudi plans. The developed world has been trying to move away from the consumption of fossil fuels for many years and to replace them with cleaner eco-friendly renewables. Whilst we are a considerable way from achieving that goal progress has been made. For example many modern cars are much more fuel efficient than their counterparts of even a decade ago. Of course for most of the last 15 years the developing world has been picking up the slack, as economies there grew rapidly, prompting increased energy demand from both businesses and consumers. But as these markets and in particular China, slow down, so their levels of energy demand falter as well. These changes may appear to be marginal, but they are having a profound effect on both Oil prices and investor sentiment.
For now Oil prices remain depressed and may realistically have further to fall. We flagged $25 per barrel, as our target for WTI back in August 2015 and again in October and of course prices have a habit of over extending during periods of capitulation, which we haven't yet seen in Oil .
However markets are forward looking, some experts believe that the current imbalances within Oil will be removed from the system by early to mid by 2017. WTI futures contracts for June and December 2017 trade at more than a 20% premium to the current price (although of course the cost of carry is part of that premium). One thing seems certain and that is that the Oil market is unlikely to be dull over the coming weeks and months.
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