As much as I love Christmas and year end celebrations, this is not a great time of year for me for one reason. The expectation is that I will write a piece like this, predicting what will happen over the next twelve months. Predicting is what I do, of course, so you would think it would not be a problem, but these year end pieces are different. Usually, I get to state the time frame of a move implied by my research. Some things have an immediate effect that will show itself in a couple of days, while some predictions may be designed to play out over a period of months. Forecasting where any commodity or stock will be at a specific point in the future, though, is virtually impossible given the number of variables at play. Still, it’s the holiday season, so I will have a stab at it anyway regarding WTI.
Traders look forward, but they inform that view by looking backwards. It is therefore impossible to predict anything for 2018 without looking at what happened in 2017.
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WTI started the year looking as if it had found a level, with a couple of months of trading in a tight range just above $50. That ended in March, however, and we spent the next four months forming a giant, five-wave-Elliott pattern downwards that formed a bottom around $42. Then, after OPEC and others agreed to limit production and global economic growth began to pick up, we started a recovery that took WTI past its starting point and into the high $50s, levels not seen for nearly three years.
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As we look forward, though, the picture is changing. Domestically, the growth on the demand side is set to continue, if not even increase as the stimulative effects of the tax cuts in the U.S. are felt. That would under normal circumstances give a boost to global growth too, but the anti-free trade “America First” policy coming out of the White House makes that an uncertain proposition next year.
The real driver of oil next year, though, will be the supply side of the equation. What we have seen over the last couple of months is that U.S. producers are stepping up production, even as others are cutting back. The cuts have made a dent in the global oil glut, hence the price appreciation in the second half of the year, but U.S. output keeps increasing to offset that. The IEA recently upgraded their forecast for U.S. crude production, and it is hard not to agree with that view. If that happens, the OPEC et al agreement will come under immense pressure. Why restrict production to benefit U.S. firms not bound by the agreement? If anything, with the EPA now allowing deep-water drilling, drilling on Federal lands, and drilling in the Alaskan Wildlife Refuge, the pace of output increase could be even higher than generally thought.
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That output increase will naturally put downward pressure on WTI, but the effects of that pressure will be exaggerated by the fact that hedging at these levels has been extensive over the last couple of months. That is a natural reaction of E&P companies after so much volatility in the last few years and has capped the current rally to some degree, but the biggest effect will be in the longer term. Even if prices do start to fall gradually early next year there will be no incentive for well-hedged producers to cut production. That will exaggerate downward moves, and makes a break of $50 distinctly possible. In fact, I will go even further and predict that quite early next year we will see a big drop back into the low $40s.
Oil, like other commodities tends return to the mean though, which means a recovery of sorts is likely when that happens. However, the long-term, multi-year outlook for crude will put a pretty tight cap on that. Electric vehicles are coming, and they are coming faster than most anticipated, so given that over seventy percent of U.S. oil output is used for transportation it is hard to be enthusiastic about the long term outlook for American crude prices.
The logical conclusion then is that we will finish next year significantly lower than we did this. Something like a major conflict in the Middle East that affects global supply could negate all that of course, but all else being equal, I expect oil to struggle in 2018. So, predictions over, I wish you all a Happy Holiday season, and a happy, healthy and prosperous 2018!
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By Martin Tiller for Oilprice.com
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