It’s all about oil – that’s the sweet crude truth!

China has endured two massive stock market shutdowns – one on Monday, January 4, and another on Thursday, January 7. These are reminders that the primary stress factors remain in place and that a Chinese recovery is nowhere to be seen. Oil prices recently bounced back from 12-year lows, settling a sliver above $34 per barrel. A big part of the reason for the ongoing weakness in oil prices is the resilience of WTI crude oil producers in the US.
Even as prices continue to slide, shale oil producers are maintaining output capacity – feeding the supply glut that is dragging prices lower. The current price of crude oil is unsustainable for US producers and many OPEC countries too. However, neither side is prepared to cede market share to the other. The recent rebound in the oil price is not something that analysts should read too much into however. The technical correction is a once-off event that does not make the case for a compelling argument in favour of oil price increases. The fundamentals of the market are structurally imbalanced. As long as China weakness persists, global demand remains weak, oversupply continues, and the USD remains strong we are going to see persistent weakness in crude oil prices.

IRAN AT THE CENTRE OF A BREWING STORM

One of the biggest drivers of recent low prices is the feud between arch-rivals Iran and Saudi Arabia. Both countries are members of OPEC and both are high-powered global players. What typically happens when geopolitical turmoil comes into play is that oil prices spike. This is what happened initially when news broke of Iran’s condemnation of Saudi Arabia’s execution of a Shiite cleric. However, the longer term effect of the feud is that neither country is prepared to abide by production decreases. And that is precisely what is driving the price of oil so much lower in recent days.
Without crucial production cuts, there is no way that OPEC can work towards increasing the price of Brent crude. The demand/supply conundrum requires one of two things to happen: Either production is curtailed so that demand can clear output at a higher price, or a shift in demand takes place and that raises prices. The latter scenario could only occur if China suddenly had a remarkable recovery and started buying energy commodities like crude oil en masse. With sanctions on Iran about to lifted, the country will be able to export up to 500,000 barrels per day to international markets. With oversupply standing at some 2 million BPD, this seems disingenuous to the embattled energy sector.
Iran has a list of customers ready and willing to purchase its oil and this does not bode well for the price of WTI and Brent crude oil. There are even reports circulating that Saudi Arabia is lining up buyers across Europe to purchase its crude oil instead of Iran’s crude oil as simmering tensions between these two countries continues. Owing to the inclusion of Iran in global oil, it is possible that oil prices could drop further. Analysts are convinced that given these realities, prices could drop below the critical $30 per barrel level and head into the mid-to-low $20 range.

WILL WE EVER SEE $100 PER BARREL OIL AGAIN?

The thought of oil prices rising towards $100 per barrel seems highly improbable to say the least. Given the tumultuous activity in oil markets of late most everyone is likely to agree that $100 per barrel oil is anything more than a pipe dream for producers. For consumers the prospect of oil at that price is enough to send shudders down their spines. Gasoline prices at the pump have been hovering around the $1.90 range for quite some time and motorists are rightly satisfied with the disinflationary effect that oversupply is having on the price of crude.
In 2015, US shale oil and natural gas producers and investors endured a torrid time. Rapid and unprecedented declines took place and some 250,000 jobs were sacrificed in the process. The tense standoff between OPEC and shale oil producers has resulted in nothing but oversupply and declining revenues for everyone. The fact of the matter is that OPEC will simply not allow oil prices to rise to $100 per barrel ever again. There is simply too much at stake because prices like that would empower WTI crude producers and drive up their profits accordingly. So, instead of everyone getting a slice of the cake, OPEC wants to starve out US oil producers with historically low prices. If prices rise to $100 or thereabouts, we will see some interesting realities taking shape:
– Domestic imports of OPEC oil will decrease;
– Domestic production of crude oil will increase;
– Domestic consumption of crude oil will decline at those prices.

WHY IS OPEC ALLOWING OIL TO REMAIN AT $35 PER BARREL?

This is a question that continues to plague casual observers in this unfolding saga. The fact of the matter is that OPEC is the most significant marginal oil producer. What it does in terms of its 33% share of production is tip the scales one way or the other. If OPEC allows prices to drop, it is squeezing out high cost producers (like the US) and causing rig counts to diminish. When OPEC believes that enough higher cost producers have been squeezed out and global production of oil is substantially less prices will naturally begin rising – even without a cut in output for OPEC. That is what the war of attrition is all about; OPEC is trying to literally squeeze out other producers so that prices can rise and it can claim a larger slice of the global market. So how long is OPEC prepared to play the waiting game? This is the million dollar question but it could be anywhere up to five years or more. By that stage, tremendous progress will have been made on electric-powered vehicles and that will put a big dent in the demand for crude oil!

Please note that this column does not constitute financial advice.