By John Richardson
FIRST of all, we were told that $100 a barrel, or thereabouts, was the natural price for oil.
And then we were told this after the price collapse: “Not to worry, this is just a temporary supply glut. Output cuts will soon be sufficient to restore the price back to the region of $100 barrel.”
There is a third more recent theory doing the rounds, which roughly goes as follows: “OK, prices might now not return to $100 a barrel for a good while, but we are heading towards a new period of price stability. Output will be reduced later this year, which will result in Brent prices stabilising in the region of $60 a barrel.”
And, of course, there is the usual “hold the hands up in the air” approach, which increases in popularity during times like this. This again can be approximately summarised as the following: “Trying to forecast oil prices has always been ‘Fool’s Gold”, and so your guess is as good as mine”.
To that end, a few weeks ago I asked a friend, who knows nothing about energy markets, to pick a number, any number, between 30 and 60. She picked 47. The following Friday, WTI was trading at $47.36/bbl.
All of the above is obviously no value whatsoever to petrochemicals producers or buyers who are struggling to manage their raw material and finished-product inventories. If you make the wrong call on today’s price recoveries in some petrochemicals markets – for example, in polyolefins in Asia and Europe – you could end up in a lot of financial trouble.
So, in an effort to clear away some of the fog, all of us must first of all think about why so many people have got oil markets so badly wrong. The reasons can be summarised as follows:
- Analysts and oil companies thought $100 crude indicated strong underlying supply and demand fundamentals. But this price level was instead the result of central bank stimulus incentivising speculators to drive-up the price of oil.
- Last year’s price collapse can be explained by the withdrawal of stimulus. As the tide of easy money began to retreat, it became apparent that too much new supply was chasing too little actual demand.
- The next mistake was to assume that Saudi Arabia would reduce output in attempt to restore prices to $100 a barrel. It has instead chosen to defend market share.
- All the above errors were compounded by the belief that high-cost oil producers would swiftly make output cuts sufficient to restore prices to their old levels. They have instead chosen to pump more rather than less oil for debt repayment reasons.
- Countries heavily dependent on oil-export revenues also appear to be following the same path.
Last week, Saudi Arabia reiterated its market share approach. And earlier this week, a Reuters’ survey indicated that OPEC as a whole had raised March output to its highest level since last October.
Meanwhile, inventory levels in the US continue to indicate strong levels of shale-oil production. Last Wednesday, again according to Reuters, they rose to 466.7 million barrels – another 80-year high.
Canada’s oil sands industry is another area of high cost production where swift cuts in output had been expected.
But some oil sands projects are at a late stage of development and have already sucked-in billions of dollars of investment. So these projects will be completed and will come on-stream.
Iran is one of the countries heavily dependent on oil revenues. If a nuclear deal is reached with the West later today, Iranian exports might eventually recover to their 2011 level of 2.5 million barrels a day as production is increased. Exports had fallen to just 1.1 million barrels in 2013 because of sanctions.
Iran also has between 7 million and 35 million barrels of oil in storage that could more quickly disrupt the global crude market.
Equally, of course, there could no nuclear deal with the West and the conflict in Yemen might add another “geopolitical premium” to the cost of oil.
As the New Normal further develops, how on earth do you go about managing your inventory levels if you are a petrochemicals producer or buyer? Here are some suggestions:
- Back in H1 2014, it was possible to get away with a narrow range of oil-price forecasts. Now, though, you need to build a much-wider range of scenarios for your business.
- These scenarios need to include reversion to the average price of crude over the last 150 years, which, inflation adjusted, is just $30 a barrel.
- It is equally possible that geopolitical factors could temporarily push prices much, much higher than this. But this will only be temporary, as the longer term supply and demand fundamentals have never really supported $100 a barrel crude.