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Oil Prices: Why We Are Where We Are Today

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By John Richardson on 04-Aug-2015


By John Richardson

CrudeBrentlastTWO months ago, when I was delivering a training course, people responded with deep scepticism when I suggested that oil-price stability at around $65 a barrel wouldn’t be sustained during the second half of the year. And when I suggested the price would soon fall to below $50 a barrel, the reaction of the audience was even more disbelieving.

It continues. Only last week, when I suggested that there was no reason why crude might not fall below $40 a barrel later this year, the reaction of several chemical industry contacts was again, “Surely not?”

So why have I maintained my bearish view on crude? Here are my five main reasons:

  1. Oil markets, for too many years now, haven’t followed the fundamental laws of supply and demand. Vast quantities of easy economic stimulus money flowed into futures-market speculation, creating the need by these speculators, because of their positions, to constantly talk-up up the price of oil to ensure that it stayed in the region $100 a barrel. It didn’t matter if the facts didn’t actually fit their story. All that mattered was that they convinced enough of the people for enough of the time that their story was right.
  2. Easy stimulus money also flowed into oil-supply investments, particularly in the US, regardless of the signs as early as in 2011 that global demand would not be sufficiently strong to absorb these new supplies.
  3. And the problem is that we are talking about truly vast new supplies of both oil and gas during a period when the global economy is a lot weaker than many people had expected.
  4. US shale-oil producers, for the time being at least, continue to maintain high levels of output. This is partly because, as I first argued last October, a few cents profit on each barrel of oil is better than no cents at all if you are trying to pay-back your debts. The cost efficiency of the shale process is also constantly improving.
  5. The Saudis are playing the long game in order to maintain market share – hence, June saw another record level of production. Saudi Arabia also knows that global oil consumption growth is likely to slow very dramatically because ofclimate-change concerns. They don’t want to end up being forced to leave their most valuable national asset in the ground, and so they intend to pump as hard as they can for as long as they can.

Why did prices recover from February onwards to a high for Brent of $69.39 a barrel on 5 May? This was again because of futures markets. A large number of speculators gambled that supply was about to tighten, even though the evidence had yet to emerge of significantly tighter supply.

Throughout this rally, it always felt as if it was only a matter of time until this expectation was proven to be unfounded. That time has now arrived as we also prepare for a sharp increase, rather than decrease, in supply because of the Iranian nuclear deal.

Global demand is also getting weaker, mainly because of events in China. Yesterday, for instance, it was announced that the final Caixin/Markit China Manufacturing Purchasing Managers’ Index for July had dropped to 47.8 from 49.4 in June. This was the lowest in two years.

Nobody can predict geopolitics. But other than an unforeseen major geopolitical event, it is hard to see how crude will not continue to fall over the next few months as it continues to its return to its long-term historic average price of  $30 a barrel. And as this process unfolds, prices could well dip below $30 a barrel.