728x90 AdSpace

Latest News
February 23, 2015

Not $100, Nor $20: Oil Bulls and Bears Need to Get Real


By Commodities Now

London, February 2015
Oil bulls and bears need to stop talking their books and get real. Crude isn’t going back above $100 a barrel – at least not anytime soon. Nor is it falling to $20.
How can I be so sure? A confluence of political, economic, and, most importantly, technological changes are having a major impact on the way we produce and consume oil, making it both cheaper and more abundant. Barring some major international conflict, oil prices will most likely be range bound for quite a while, with a floor of somewhere around $40 a barrel (where we have seen massive rig count and CAPEX reductions) and a top around $80 a barrel, above which production really ramps up.

The sharp drop in oil prices last year managed to catch pretty much the entire market off guard. West Texas Intermediate crude (WTI) has fallen from a high of over $100 a barrel in June to a low in the mid-$40’s last month. But the recent rebound in oil prices, which sent WTI to as high as $58 a barrel, has oil bulls ready to tell the market, “I told you so.” They believe that, even though WTI prices have weakened slightly from their highs in the last week to around $52 a barrel, the overall trajectory of oil prices is up and we will be testing $100 a barrel again in short order.
The oil bulls and bears
So who are these oil bulls and should we listen? They come in all shapes and sizes, ranging from Big Oil executives to small day traders. For example, John Hofmeister, the former head of Shell’s operations in the U.S., has publicly come out as an oil bull. He recently said he thought crude would rebound this year to around $80 to $90 a barrel and could even hit the triple-digits by early next year. Legendary Texas oilman T. Boone Pickens is another oil bull. He hasn’t been shy about telling pretty much anyone who’ll listen he believes oil will breach $100 a barrel in the next 12 to 18 months. He blames domestic shale oil drillers for the recent slump in prices and thinks that they will stop pumping and constrict supply in short order.
But we really need to consider the sources here. Hofmeister is retired and Pickens has a record of straight talk, so they seem like trustworthy folks. But it turns out that both men have vested interests in projects (or “plans“) that promote the use of natural gas as a transportation fuel alternative to gasoline, which of course is made from crude oil. The case for the use of natural gas as a transportation fuel makes a lot of sense when oil is above $100 a barrel, but it is a really hard sell to investors when oil is sitting at around $40 to $50 a barrel. It could be these men, and many others like them, are just talking their books.
So how about the banks? Years of regulatory pounding have helped to make the analyst space far more trustworthy than in the past, so they may not be such a bad alternative compared to those who have a more vested interest in where the price ends up.
The oil analysts at Goldman Sachs see oil prices averaging around $40 a barrel for the first half of the year, while those over at Barclays see prices averaging between $44 a barrel and $72 a barrel. Goldman is mostly concerned that U.S. inventory builds, averaging 1 million barrels a day since the end of December, has created an enormous glut in supply that they believe will take a while to eat through and keep pressure on pricing.
But Goldman isn’t the biggest bear out there. The analysts at Citibank put out a provocative note recently in which they claimed that oil could go down to as low as $20 a barrel. That scenario seems pretty far-fetched to me given that the marginal rate of production for most oil wells around the globe is higher than $20 a barrel; so, while it is theoretically possible, prices would really struggle to make it that low in the first place and couldn’t stay down there very long.
Despite Citi’s ultra-bearish headline, the bank’s analysts make a number of solid points in their pieces. Most notably, they believe that when prices begin moving to the upside, producers who have recently capped their wells will begin producing again at a much higher rate than in the past. As such, even the slightest increase in oil prices will most likely be matched with a commensurate increase in supply, thus keeping prices from shooting up.
Citi’s rationale makes sense as it takes into account advances in drilling technology, which allows producers to more easily seal off and reopen wells than in the past. It also takes into account the kind of drilling associated with this latest boom, shale drilling. It is much easier and cheaper to shut down and restart a small shale well compared with one being drilled in the ultra-deep waters of the Gulf of Mexico. As such, U.S. shale wells will act as a sort of “swing supplier” that intervene in the market when prices get too high. But the advance in shale technology is just one of a handful of new factors helping to cap oil prices. For example, recent breakthroughs in mapping and seismic technology are making dry holes a thing of the past, helping to boost production across the globe.
Technology and geopolitical factors impacting demand
Technology is also having an impact on the demand side of the equation as well. There have been a number of major advances in renewable energy and “green” alternatives to fossil fuels in the last few years that have soured demand for crude, especially in the Western world.
For example, we are already seeing electric-powered cars on the road, but advances in battery technology could make the electric car a truly viable alternative to gasoline-powered cars in the next five years. Researchers at Yale and MIT have developed so-called “lithium-air” batteries, which reduces the energy needed to recharge the battery, making it lightweight and more efficient and cheaper to produce.  There are also a number of companies racing to make a more efficient battery as well. Seeo, a small company out of California, says their so-called “solid state lithium ion” battery, which is based on a proprietary polymer electrolyte called DryLyte, can hold more energy than today’s conventional lithium-ion batteries at a tenth of the size.
These new battery technologies would extend the range of electric cars and make them more accessible to the general public. They theoretically give electric cars the same range as gasoline vehicles, overcoming so-called “range-anxiety”, which has held back many consumers from making the switch from gasoline to electric.
While electric cars are generally a threat to crude demand in the developed world, in the developing world, most notably in the so-called BRIC nations, oil is still king. But slow economic growth in the developing world is likely to keep crude growth at a minimum, at least for the next year or so. For example, China’s economic growth rate is half of what it was back in the boom days and is expected to remain lukewarm for the foreseeable future. Brazil’s economy is in the tank, as well, with its currency hitting new lows against the US dollar. Its economy isn’t expected to grow at all this year. And then there is Russia. The drop in oil prices combined with economic sanctions have had a significant impact on the Russian economy and there is no end in sight.
The confluence of weak fundamentals and a sluggish global economy means that oil will probably stay in the double-digits throughout this year and maybe next, somewhere between $40 a barrel to $80 a barrel. To be sure, geopolitical risk could change the entire equation. The world’s oil fields are running at a utilization rate of 98%, so there is little spare capacity to make up for a major disruption in supply, be it from Opec slashing production, which is unlikely, or an increase in violence in the Middle East or the Ukraine.
Barring that, while we might all enjoy the price at the pump, it will make for long, boring days on trading floors around the world
Ends --

Source: Forbes, Chip Register,  Sapient Global Markets, February 19, 2015 via Commodites Now (EconMatters author archive here)  

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

© EconMatters All Rights Reserved | Facebook | Twitter | Email Subscribe | Kindle

  • Blogger Comments
  • Facebook Comments
Item Reviewed: Not $100, Nor $20: Oil Bulls and Bears Need to Get Real Rating: 5 Reviewed By: Econ Matters