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Irina Slav

Irina Slav

Irina is a writer for the U.S.-based Divergente LLC consulting firm with over a decade of experience writing on the oil and gas industry.

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Forget Oil Price Forecasts, It’s Just Another Cycle

Barrels

Profit season in the oil industry is in full swing, and the mood is upbeat: strict financial discipline is paying off, cash flows are improving (or emerging after a long absence), and the industry is growing again. And there are those who claim that we have seen the last big oil price collapse.

Some beg to differ however. A notable voice among the skeptics is Reuters market analyst John Kemp. In a recent column Kemp lays out in detail the reasons why the “It will never happen again” refrain is wishful thinking at best and delusion at worst. The oil industry, he says, has a cyclical nature. Learning from past mistakes, while a good thing generally, cannot help avoid the next bust because boom and bust is the very nature of oil.

With the scars from the last bust still fresh, the oil industry is being cautious with new investments, just as it has been after every single bust since the dawn of oil, Kemp notes. Oil companies are suspicious of the price rise, uncertain it will last. And they are quite right to be suspicious, because no boom ever lasts as history has proven time and again. The problem is that nobody can predict the end of the next cycle and the beginning of a new one, hence the caution.

So, if nobody can predict the next price collapse, what is the point of having analysts fall over themselves to forecast the unforecastable, namely, future oil prices? Well, here’s a pertinent quote from John Kenneth Galbraith: “Economists don’t forecast because they know, they forecast because they’re asked.”

Economic forecasts are notoriously inaccurate, and this is particularly and very emphatically true of oil price forecasts. Here’s another quote, from Rex Tillerson: “We’ve never been good at predicting these (price) cycles, neither when they occur nor their duration. We don’t spend a lot of time even trying.” That’s certainly a smart approach and one that must pay off by saving time, effort, and money. Related: Are Investors Turning Away From Big Oil?

The reasons why predicting the next oil industry cycle is mission impossible come down to the makeup of the oil market and the huge diversity of external factors that have a bearing on prices, and therefore on the cycles. The oil market, Kemp says, is actually a collection of numerous submarkets, and these are well-nigh never in balance. When they are in balance, it’s only for a very short time, so the phrase “balancing the market” is basically nonsense.

Outside the market there are thousands of events that can affect oil prices and there is no way on earth anyone can account for each and every one of these thousands of events, ranging from local politics in oil producers and consumers to force majeure events. As Bill Gilmer, director of the Institute for Regional Forecasting at the University of Houston puts it, the world does not stand still, so the chance of any one analyst or Big Oil CEO getting the price right is pretty much the same as the chance for a tail or a head in a coin flip.

So, what is an industry to do in this environment of chronic uncertainty? Ride the cycle, Kemp says. So, producers vow to continue with the strictly disciplined approach to investments. The result will be higher prices stimulating alternative producers, a supply build, and a subsequent fall in prices. Just like every other cycle. The only thing producers could reasonably do, whether Big Oil or OPEC, is plan for the long term and learn to live with the short-term uncertainty.

By Irina Slav for Oilprice.com

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  • Robert Craig on April 27 2018 said:
    Bull markets climb a wall of worry...

    US Shale up by 25% in two years from ~9mbopd to ~11mbopd... Annual depletion running at 3%-6% of global supply which is, say 4-5mbopd *loss* per year. Surplus capacity now all eaten away. Stockpiles depleting month-on-month... Global investment *slashed* over last four years... oil supply crunch is coming - its just a question of when...
  • Steve on April 27 2018 said:
    It wasn't long ago that most analysts were saying 40 to 50 dollar oil was going to be the norm and we would never see 100 dollar oil again. I have worked in the energy industry for over 38 years surviving several cycles and one thing is certain is that analysts never get it right. I think the big question is how much higher oil will go above 100 dollars and for how long. EiA forecasts that fossil fuels will still have 80 percent worldwide share of energy consumption by 2050 so EVs will not lead to much oil demand destruction that many people think. Another thing for certain is that oil and hydrocarbons in general are valuable commodities that have been far to cheap the past 4 years in the US and is necessary for our good quality of life. Time to pay the piper.
  • Jeffrey J. Brown on April 27 2018 said:
    A trip down memory lane, to early 2016:

    GARTMAN: Crude oil will never trade back above $44 'in my lifetime’ (January 26, 2016)

    http://www.businessinsider.com/dennis-gartman-crude-oil-call-2016-1

    Excerpt:

    Dennis Gartman has a call on oil.

    Gartman said Monday that he thought crude oil wouldn't trade back above $44 "in my lifetime," though he did say oil may have hit a short-term bottom.

    The price of crude oil, which has been driving the price action in the stock market for the past month, fell about 7% Monday but bounced back a bit early Tuesday.

    Gartman is the publisher of the widely read "Gartman Letter," a daily markets newsletter, and is an omnipresent voice on CNBC. His calls are also often chronicled on Zero Hedge and taken as a contrarian indicator: When Gartman says he wants to be "long of" something, short it, and vice versa.
  • Jeffrey J. Brown on April 27 2018 said:
    Neil Dwane, with Allianz Global Investors, issued a report in May, 2017 in which he outlined "Five reasons to expect higher oil prices." The five reasons are listed below.

    Note that Brent averaged $46 in June, 2017, and Brent currently is at $74, up 60% from the mid-2017 monthly price.

    Five Reasons to Expect Higher Oil Prices:

    1) Global oil demand is reassuringly stable

    2) Multiple factors will constrain the oil supply

    3) New discoveries are dwindling

    4) The US shale industry has problems

    5) Domestic production is falling in a booming Asia


    Note that Mr. Dwane references Mexico as a point of concern, but Mr. Dwane did not get into Mexico's problem with net oil exports, and Mexico's net oil exports fell by about 50% from 2016 to 2017.

    In any case, Mr. Dwane was interviewed on CNBC in July, 2017 and he made the following points:

    There's still a major reason why oil could jump back to $120, experts say

    http://www.cnbc.com/2017/07/07/theres-still-a-major-reason-why-oil-could-jump-back-to-110-experts-say.html

    Oil supply could easily be threatened by geopolitical risks, and such a disruption could cause oil prices to skyrocket, experts tell CNBC.

    Neil Dwane, global strategist and chief investment officer of European equity at Allianz Global Investors, warned that oil production supply is looking threatened around the world.

    "Venezuela's 2 million barrels of oil a day could literally go any day. Mexico looks poor. Azerbaijan's in trouble. China's own production is collapsing rapidly," he told CNBC's Squawk Box on Friday.

    "One only has to have one mistake and the only thing you'll be talking about all morning is oil at $120."

    Dwane said geopolitical risks could cause prices to skyrocket as several oil producing states are fragile, and oil prices are currently too low for anyone to want to drill fresh wells which may be needed in the future.
  • Maven on April 27 2018 said:
    Tillerson's comment explains why XOM is in the toilet.

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