By John Richardson
EVERY time the oil price stabilises for just a few days there is pretty widespread talk of the market having found a bottom and that a rebound is about to begin.
A case in point was last week, when, before the oil price fell below $50 a barrel, two days of relative crude-price stability led to talk that at a bottom had at last been found.
And if you go back to H2 last year, the pattern was the same. Each time the price stabilised briefly at $80 a barrel, $70 a barrel and $60 a barrel, there were pretty widespread discussions that prices would both settle down and bounce back.
Petrochemicals companies that stocked up on naphtha when crude briefly stabilised at all these different levels will, of course, now be realising substantial inventory losses. One source told me today that these losses might be so severe that the very survival of some companies could be in jeopardy.
Yet still, I was also told today that the majority of people in the petrochemicals business think that crude will recover to $70-90 a barrel by the end of this year.
This very risky assumption as I believe there is every chance that oil could go down by another $20 a barrel – perhaps even more (more on this subject in later posts).
The risk in this $70-90 a barrel assumption is that petrochemicals purchasing managers will buy even more naphtha ahead of a recovery that might not happen. They may, as a result, cause further inventory losses.
Don’t be taken in by upside oil price forecasts without studying closely what independent bodies such as the International Energy Agency (IEA) are saying. The IEA has pointed out thatwhilst supply for crude would continue to grow this year, demand will also weaken.
On the supply side, think about human nature and history. Why high would high cost producers quit after only a few months of lower prices? A few cents in the dollar of debt payback is better than no cents at all.
And even if these producers were to go bust, who can be sure that they will not bought by, say, a private equity company with debts written off? Then, of course, the private equity companies would be able to run these oil reserves hard, almost regardless of the price of oil.
I also maintain that one of the biggest reasons for weaker demand for crude is the once-in-several-generations economic, social and political changes taking place in China.
Once you have accepted that oil prices might go down by another $20 a barrel, perhaps even lower, prepare for what this will mean for economic growth.
On balance, I worry that there is more of an immediate downside than upside for cheaper oil. “Quietly, a global crisis is developing because of deflation. Deflationary trends were already strong before the oil price started to fall. The declines in crude have, obviously, exacerbated these trends,” said a source with a global polyethylene producer.
Once you have built into your scenarios crude at $30 a barrel and lower, you must also look up and down your production chains to discover who is aligned with your view. If, for example, your customers are not aligned then they represent a major accounts receivables risk.