22 December 2015

Oil price: who is betting on a recovery in 2016?


The oil price has been in recovery in recent days. Having hit a post-crisis low of close to $36 a barrel on Monday, it has since rallied and at one point yesterday it was back above $38 a barrel.

But this is still a painfully low price, close to 70 per cent below the September 2014 peak. While unprecedented production efficiency has protected drilling companies in a way few thought possible, in the North Sea, for example, it is still supposed to cost approaching $50 to extract a barrel of oil. This should be significantly higher in US shale oil fields.

The situation is worse for those countries that depend on oil as a source of income. Many Opec members in financial difficulty, such as Venezuela and Nigeria, the de facto cartel leader Saudi Arabia and even non-Opec export giant Russia, all designed budgets around oil prices in excess of $100 a barrel.

As investment is rapidly withdrawn and spending cut, these companies and countries are hoping prices will recover more quickly than markets currently expect. Encouragingly for them, there are experts who see that happening.

Liam Halligan wrote in the Daily Telegraph this week that prices will recover faster, as investment cuts are ramped up to cope with the latest price crash. Elsewhere, The Times reports that the Wellcome Trust has substantially increased its investment in energy stocks such as Shell and BP as it "builds into what markets are doing" and takes advantage of perceived bargains ahead of an inevitable recovery.

Reuters says that there is also a wider market bet gaining traction for prices to recover to between $50 and $80 in 2016, with derivatives that would pay out in this range climbing "steeply" in recent weeks.

The downside is that investors broadly see this happening in around 12 months at the very end of 2016. Near-term bets are still on further falls, perhaps to around $30 in the early months of next year as Iranian exports re-emerge from behind international sanctions.

It will take an output concession from Opec to push the price higher sooner – and the group has seldom looked less cohesive on its production policy.
Oil price misses 11-year low – but for how long?

15 December

The oil price recovered in afternoon trading in New York yesterday, after coming close to 11-year lows earlier in the session.

International benchmark Brent crude had earlier tumbled below $37 a barrel in London and settled just 13 cents above the $38.20 it reached in September 2008 in the teeth of the global financial crisis.

Below this, it would be at the lowest level since July 2004, Reuters notes, when it briefly languished in the mid-$30 range after a protracted recovery from a single-digit mid-1990s trough.

The rally yesterday, during which Brent bounced back two per cent, was not driven by particular fundamentals.

Rather, it was a function of inevitable volatility in a market that is currently beset by 'short' bets on a lower price. This morning Brent was sitting a little above $38 a barrel, which is still unprofitable for most production.

'Long' positions – bets on a higher price – are now at the lowest since records were first compiled in 2009.

This means two things: there will probably be some wild swings, as 'short positions' are rapidly covered any time the price ticks upwards even slightly; and most traders and analysts are still convinced the market has not found its bottom.

Where could that bottom be? A technical analysis has been offered by legendary data trader Daryl Guppy, who writes on CNBC that current trend charts indicate "prices have further to fall".

Based on historical support levels and general trading patterns, he sets a main target for the price floor at a little below $30 a barrel, near that 2004 nadir.

There is a consensus fast emerging that a price around this level will be reached before the supply glut clears next year - but there are those who believe if this does happen it will presage a faster recovery than some are currently expecting.

Echoing the Shell chief executive Ben van Beurden, who warned in October that rapid retrenchment could cause oil prices to spike, Nick Cunningham writes on Oilprice.com that another big step down in prices could "spark deeper cuts to spending and drilling, which could perhaps contribute to an accelerated pace of adjustment".

Oil Prices: What’s Behind the Drop? Simple Economics





Brent crude, the main international benchmark, was trading at around $36a barrel on Monday.

The American benchmark was at around $36 a barrel.

Why has the price of oil been dropping so fast? Why now?

This a complicated question, but it boils down to the simple economics of supply and demand.

United States domestic production has nearly doubled over the last six years, pushing out oil imports that need to find another home. Saudi, Nigerian and Algerian oil that once was sold in the United States is suddenly competing for Asian markets, and the producers are forced to drop prices. Canadian and Iraqi oil production and exports are rising year after year. Even the Russians, with all their economic problems, manage to keep pumping.

There are signs, however, that production is falling in the United States and some other oil-producing countries because of the drop in exploration investments.

On the demand side, the economies of Europe and developing countries are weak and vehicles are becoming more energy-efficient. So demand for fuel is lagging a bit.



Who benefits from the price drop?

Any motorist can tell you that gasoline prices have dropped. Diesel, heating oil and natural gas prices have also fallen sharply. Households are likely to spend $750 less on gas this year because of the oil prices, the United States Energy Information Administration said in January. Europeans and consumers around the world will enjoy similar benefits.

The latest drop in energy prices — regular gas nationally now averages around $2.03 a gallon, compared with $2.70 a year ago — is also disproportionately helping lower-income groups, because fuel costs eat up a larger share of their more limited earnings.

Gasoline prices are now inching down as refineries finish their maintenance to switch to more inexpensive winter gasoline blends.

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As the price of crude oil fluctuates, why some countries are faring much better than others.CreditVideo by Quynhanh Do on Publish DateJanuary 27, 2015
Who loses?

For starters, oil-producing countries and states. Venezuela, Iran, Nigeria, Ecuador, Brazil and Russia are just a few petrostates that are suffering economic and perhaps even political turbulence. Persian Gulf states are likely to invest less money around the world, and they may cut aid to countries like Egypt.

In the United States, Alaska, North Dakota, Texas, Oklahoma and Louisiana are facing economic challenges.

Chevron and Royal Dutch Shell recently announced cuts to their payrolls to save cash, and they are in far better shape than many smaller independent oil and gas producers that are slashing dividends and selling assets as they report net losses. Other companies have slashed their dividends.
What happened to OPEC?

A central factor in the sharp price drops, analysts say, is the continuing unwillingness of OPEC, a cartel of oil producers, to intervene to stabilize markets that are widely viewed as oversupplied. Prices of OPEC’s benchmark crude oil have fallen about 50 percent since the organization declined to cut production at a 2014 meeting in Vienna.

Iran, Venezuela, Ecuador and Algeria have been pressing the cartel to cut production to firm up prices, but Saudi Arabia, the United Arab Emirates and other gulf allies are refusing to do so. At the same time, Iraq is actually pumping more, and Iran is expected to become a major exporter again under the recent nuclear deal.

Saudi officials have said that if they cut production and prices go up, they will lose market share and merely benefit their competitors. They say they are willing to see oil prices go much lower, but some oil analysts think they are merely bluffing.

The death of King Abdullah in January prompted speculation that Saudi Arabia could shift direction, but there has been no softening in the Saudi public position in recent days. But for the immediate future, most analysts say the Saudi royal family will resist any sharp changes in policy, especially as it tries to navigate multiple foreign policy challenges, like the chaos in neighboring Yemen.

If prices remain low for another year or longer, the newly crowned King Salman may find it difficult to persuade other OPEC members to keep steady against the financial strains. The International Monetary Fund estimates that the revenues of Saudi Arabia and its Persian Gulf allies will slip by $300 billion this year.

Is there a conspiracy to bring the price of oil down?

There are a number of conspiracy theories floating around. Even some oil executives are quietly noting that the Saudis want to hurt Russia and Iran, and so does the United States — motivation enough for the two oil-producing nations to force down prices. Dropping oil prices in the 1980s did help bring down the Soviet Union, after all.

But there is no evidence to support the conspiracy theories, and Saudi Arabia and the United States rarely coordinate smoothly. And the Obama administration is hardly in a position to coordinate the drilling of hundreds of oil companies seeking profits and answering to their shareholders.
When are oil prices likely to recover?

Not anytime soon. Oil production is not declining fast enough in the United States and other countries, though that could begin to change in 2016.

Demand for fuels is recovering in some countries, and that could help crude prices recover in the next year or two. There is now little or no spare production capacity to give the market a cushion in case of another crisis in a crucial oil-producing country.

The history of oil is of booms and busts followed by more of the same.