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Why Oil Won’t Go Below $40

Why Oil Won’t Go Below $40

When I made my energy predictions for 2015, I made some very aggressive predictions. Perhaps the most aggressive was that the closing price of West Texas Intermediate would not fall below $40/barrel (bbl) in 2015. Why do I consider this a particularly aggressive prediction? Because on the day I made it, the price of WTI closed at $48.80, but in each of the previous three months the price of WTI had dropped at least $10/bbl over the course of the month. So if WTI had maintained the same downward trajectory, it could have easily ended January below $40/bbl. My prediction could have been proven wrong before we even got out of January, so I really stuck my neck out on that one.

It’s not that there is anything special about $40, and I acknowledge that it’s possible that we could overshoot. But I made the prediction to highlight my conviction that $40 oil simply isn’t a sustainable price in today’s world.

A number of respected pundits are projecting that we will go below $40/bbl, with some suggesting that crude could even crash all the way to $30/bbl. Last week on CNBC, respected oil analyst Stephen Schork said “I do think this is a dead cat bounce”, elaborating that at least over the next 2 to 3 months that there is too much oil supply relative to current demand. My point is that it has been a widely held belief that oil is going to fall below $40/bbl, so I am definitely on the wrong side of conventional wisdom on this prediction. That’s not a safe place to be, because when you are wrong in that case people think “Everyone read this correctly except for you.”

But I think conventional wisdom is wrong in this case. Related: U.S. Supply Growth To Halt This Summer

The thing about the oil and gas markets is that traders are typically looking further down the road. It is widely expected that the supply/demand balance will tighten up in the 2nd half of 2015, so I reasoned that traders would start to position themselves well before that time. I explained the underlying basis of my prediction in that initial article, and then elaborated in the article preceding this one — Why $50 Oil Won’t Last. In a nutshell, I don’t believe the situation in 2008 — when oil prices fell into the $30s — applies today for two reasons. First, global demand is 5 million barrels per day higher than it was in 2008. Second, most of the new oil production added in the past five years came from the shale oil fields in the U.S. Most of that production has breakeven costs above $40/bbl, which is a higher break-even than the marginal oil production from five years ago.

Nevertheless, I knew that at the rate crude prices were falling, there was a very real risk that we could overshoot to the downside. I just reasoned that traders would start to bid prices back up on the anticipation that market conditions would be better for crude oil in a few months. And a funny thing happened in January. The decline in the price of WTI was much slower than it had been during the previous five months. For the first time since September, the monthly change in the price of WTI was less than $10/bbl:

DailyChangeInWTIPrice Related: Strikes The Latest Threat Facing US Oil Industry

But there is more to the story than that if you look at the rate of change over the past year. Oil prices trended slightly up during the first half of 2014, began to fall in the second half of June after peaking above $107/bbl and continued to decline throughout November. Following OPEC’s Nov. 27 decision not to cut production quotas the decline accelerated. That decline didn’t slow down until mid-January, when prices broke from the downward trend and flattened out:

DailyClosingWTIPrice

So, instead of ending January below $40/bbl, WTI finished the month at $48.24, up over 7% from the previous day’s close. This increase was despite the fact that earlier in the week the Energy Information Administration (EIA) reported that U.S. crude oil stocks rose by almost 9 million barrels over the past week to reach nearly 407 million barrels, the highest level since the government began keeping records in 1982. As I write this, the price has broken back above $50/bbl — a 17% increase in just the past week.

One thing I have noticed over the years is that when oil prices are plummeting, traders tend to ignore bullish news, and when they are climbing bearish news is often shrugged off. While oil could resume its decline this month and disprove my prediction by the end of February, the fact that the price of WTI rose despite news that should have sent it lower may indicate that we have passed the bottom. If we don’t break below $40/bbl by the end of March, I think it’s highly unlikely that it will happen for the rest of the year.

By Robert Rapier

Source - http://www.energytrendsinsider.com/  

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Leave a comment
  • Xam Takorian on February 06 2015 said:
    This guy is going to look a right burk when oil hits $10-$20.
  • Mike R on February 06 2015 said:
    At the rate the rig count is dropping and how fast shale oil wells decline in production coupled with growing demand for energy (fueled by current low prices) there is a good probability the author could be correct. The other wildcard is middle east wars and instability. A gut feel for myself is like 70-80% chance the author could be correct.
  • AC on February 06 2015 said:
    Technically, the multi-year lower trendline (originating in 1999 and running through the lows of 2001, 2009, and so far... now) provides support for your forecast.

    I believe that this rally may only be a corrective one, but even so it should reach to at lest the $60-75 range before reverting lower than $40.
  • Troon on February 06 2015 said:
    Actually, it doesn't look like S.Arabia is being very aggressive at all with their "squeeze." They could have sent the price much lower, much faster than this. It seems instead that they are simply adjusting to the fact that we can make oil for $45/bl-ish.

    Of course, the world could pump oil for much less than this . . . it's just that (even with all its flaws) America is still the most honest marketplace out there. And we can crack rock and get oil for $45/bl-ish . . . and so the cartel producers will simply have to adjust to that price in the short- and medium terms.

    Western oil companies know that the current conditions are in flux, and you can see that they are not dramatically reducing their future investments, only cutting back a little bit.

    Which is reasonable in my opinion, because in the long term we will move beyond oil. No advanced economy pays $100/bl (or even 60) for sludge you pumped out of the ground.
  • MG Masterson on February 06 2015 said:
    Every single a$$hole with a business/economic background has an opinion on this fraud. I chuckle and weep simultaneously. :( :)
  • Marv on February 07 2015 said:
    Where were you before the rapid drop in oil? Could have used someone telling me beware that all these sources of oil will IMMEDIATELY flood the supply side ... . Still do not see a regulating agency to stop over supply. Forget OPEC ..... Free market rules ... Oil does not trade like electricity. It is a random walk may be now with a preference/bias for an up.
  • Phil Flynn on February 08 2015 said:
    "This guy" comment says more about the poster than the subject matter. The only thing going to $10-$20 from here is a gallon of gasoline.

    Power Plays by Robert Rapier
  • Baffled on February 08 2015 said:
    Instead of writing 2/3 of the article about how he could have been wrong or how he apparently outsmarted conventional wisdom, it would've been nice if the author only wrote the last 3 paragraphs of the article. The first 5 paragraphs scream narcissism rather than critical-thinking or intelligence.

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