Are we scraping the bottom of the oil barrel?
The commodity markets have been rocked by persistent weakness in China and Russia and geopolitical uncertainty across the Middle East. Add to that a rampant US dollar, an embattled Canadian dollar and widespread economic instability across the eurozone and the situation becomes a little murkier. With oil prices now seemingly in freefall, what are the key facts traders need to know?
There are several givens with the price of oil:
- The stronger the US dollar, the weaker the demand for crude oil given that oil is a dollar-denominated asset
- China weakness is arguably the most important factor when it comes to global economic growth and this is evident in plummeting revenue streams for metals and energy companies in emerging market economies and developed economies alike
- The ongoing war of attrition between OPEC and shale oil producers in the US is unlikely to stop anytime soon
How low will Brent and WTI crude oil go in 2016?
CNN just published a report stating that crude oil could go as low as $10 per barrel in 2016. International banking organisations are desperately trying to get a feel for the market and forecast precisely where crude will go in the year ahead. On Tuesday 12 January prices breached the critical $30 per barrel support level, the first time in 12 years that oil has traded so low and dovetailing with an incredible 72% price decline from 18 months ago.
At the height of the global financial crisis, Goldman Sachs anticipated a price of up to $200 per barrel if supply shortages became the norm. Right now we have the opposite problem with oversupply flooding the market with black gold. Morgan Stanley anticipates a drop to $20 per barrel, while RBS expects a price of $16 per barrel. Precisely where the floor is for crude oil is unknown, but the last time that oil prices were recorded at $10 per barrel was in 2001.
The problem with crude oil prices is that they are determined by two factors – neither of which seems to be changing direction: China weakness and oversupply. On the latter point, until OPEC takes decisive action to cut output, the price rout could continue into the foreseeable future.
Will OPEC finally decrease production?
OPEC is engaged in a war of attrition with shale oil producers in the US. The battle for market dominance continues between Brent crude oil producers and WTI crude oil producers. OPEC is able to produce crude oil much more cheaply than WTI crude oil producers in the US. OPEC also has much deeper pockets and is willing to sustain lower prices for a longer period of time to drive US producers out of the market.
Ultimately, OPEC will decrease production, but only once it has met its pre-stated objective of forcing the shuttering of oil rigs in the US. However there are several dissenting voices within OPEC, such as Nigeria’s oil minister who has called for an urgent meeting at the end of Q1 2016 if prices remain low. Then of course there is the issue of Iran which is at odds with Saudi Arabia, and capable of producing 500,000 barrels of oil per day when it gets the green light to do so. Overproduction appears to be likely to continue throughout 2016, thereby depressing prices further.
How badly hit will oil majors be?
The major oil companies such as BP cannot sustain low prices indefinitely. That these companies have deep pockets is well known, and their access to credit is equally impressive. However with revenues and profits declining at a rate of knots, questions are being raised about the creditworthiness of these massive oil-mining operations which are now having to cut costs, divest from poorly performing businesses and retrench workers en masse.
Recently BP announced that it would be slashing 4000 jobs in the fields of production and exploration, owing to increasingly difficult market conditions. These layoffs are detrimental to the communities supported by oil-mining operations and myriad other complementary jobs that rely on the oil industry. This follows another 4000 positions BP slashed during 2015.
The Federal Reserve Bank of Dallas has also cautioned that $30 oil will be highly detrimental to employment in the state of Texas, which is now looking at its first loss of jobs in the oil industry in seven years. There is a growing fear that if the price of crude oil does not increase towards the $50 per barrel range, job growth will become negative for the year.
The price of crude oil in the US has been below $60 per barrel since June 2015 and, if prices remain at current levels, the jobless rate could hit 4.9% by the end of 2016. The US Energy Department is currently forecasting a price of $38.54 per barrel for WTI crude oil in 2016.
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