Is oil ready for a rebound?
Oil prices may be set to pick up, but prepare for a bumpy ride.
Crude oil prices have fallen dramatically from their peak of over US$120 a barrel just a few years ago to the mid US$30s a barrel just recently. In 2015, crude oil ranged from US$35 to US$84 a barrel. The volatility will certainly continue, but will prices begin trending higher in 2016? Some commentators believe there are signs that oil may begin to recover some of its momentum in the second half of 2016, but it will be a rollercoaster in the meantime.
Andy Lipow, who is an industry expert with years of experience following the oil market and president of Lipow Associates, believes that crude oil prices will begin to improve and begin a slow ramp towards US$55 by January 2017. As Mr. Lipow notes, that path will be more volatile than people expect and the ride may be bumpy. There is plenty of bearish news including the U.S. having reached 480 million barrels in crude inventories and the likelihood that inventories will continue to climb. This increase in supply will have a negative impact on pricing. In addition to increasing inventories, OPEC met in November 2015 and did nothing to ease the over production that is currently in place. Iran’s increased production will soon begin to hit the market as sanctions are lifted, further adding to the oversupply. Unfortunately all of this adds up to an ugly first quarter of 2016 for the oil market, leading to the possibility of US$40 or less per barrel oil.
Oil production on the decline
Mr. Lipow does see some signs for optimism. The shrinking rig count is finally having an effect and onshore oil production in the U.S. is declining. The Energy Information Administration estimated that production dropped from 9.6 million barrels per day in May and June 2015, to 9.1 million barrels per day in October 2015. In addition to declining production, the major oil companies have seen terrible upstream earnings, which will result in increasing cuts to costs, investments and jobs.
Shell, for example, cancelled its big Arctic project and its Carmon Creek Canadian oil sands project, and has cut more than 6,500 jobs worldwide. Other oil and gas plays of similar high cost or heavy investment will be delayed or will be cancelled altogether. With oil companies cutting costs, the dividend cuts will follow, with the following companies having already cut their dividends or are expected to in the near future: Denbury Resources, Cheasapeake, Transcocean, ConocoPhillips, BP, and Occidental. All of this means that oil prices will need to rise to encourage additional production.
Furthermore, Mr. Lipow believes that there is very little geopolitical risk premium in the market at the moment. As violence continues in the Middle East, and Venezuela and Nigeria deplete their foreign reserves, there will be further upside to the oil market.
In October Abdalla Salem el-Badri, the Secretary General of OPEC, publicly said, “because investment in new or expansion projects has plummeted, supply will tighten and as supply falls, prices inevitably will rise.” El-Badri also said that global investment could be down to US$130bn for 2015 from its level of US$650bn in 2014.
In the short-term it seems likely that we will continue to be at the mercy of volatile swings in the oil market, but over the longer term, as production begins to fall, some believe market pricing will pick up towards the second half of 2016.
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