By John Richardson

AS most people react like a rabbit caught in a car headlight to the latest collapse in crude-oil prices, they need to take note of this: The long term average price of oil, adjusted for inflation, is only $33 a barrel.

Why were so many misled into thinking that the natural price of oil is somewhere around $100 a barrel, and so have been caught unawares by the fall in in oil prices that first began last September? Because they were hoodwinked into believing that the huge amounts of central bank liquidity that has been pumped into the global economy since 2009, some $35 trillion, was creating sustainable new demand for oil.

What instead was happening was that oil prices only went to $100 a barrel as a result of speculators using all this cheap money to go permanently “long” on oil and other commodities. And because borrowing costs were so low, pension funds could not just leave their money in the bank. They instead chose to pour our savings into commodities in general as an alternative “store of value”.

As the above chart shows, this maintained oil prices in the region of $100 a barrel.

Meanwhile, huge investments in the supply of oil took place because a.) The cost of borrowing was very cheap and b.) $100 a barrel sent out the false signal that demand growth for oil would continue to soar for many years to come.

What we are instead seeing is a secular decline in demand for oil – and all the things made from oil – for three main reasons:

  1. Two thirds of the $35 trillion of stimulus was pumped into the global economy by China. Now that China is withdrawing stimulus in order to rebalance its economy, it is seeing low single digit real GDP growth. Economic reforms will gather pace because of big debts left over from the stimulus programme and the environmental crisis created by overinvestment.
  2. Births in 2013 in the G7 economies (almost half of the global economy) were at the lowest level since the Great Depression year of 1933.  Global fertility rates have also halved since 1950 to average just 2.5 babies/woman – and in many countries are already below the replacement level of 2.1. As the Babyboomer generation (those people born between 1946 and 1970s ) start to retire in record numbers, there are fewer young people replacing these retirees. All the data show that older people spend less money.
  3. “Doing more with less” has become the headline phrase that defines consumer behaviour and government policy, as the human-made climate change debate is essentially over. This was further underlined by the Paris agreement on climate change at the weekend. You may decide to dismiss this as “tree-hugging nonsense”, but if you do, you will be caught out by the rapid pace of change in manufacturing industries such as autos. Auto manufacturers are using supercomputer technology to make smaller and smaller cars that will need less plastic, which is of course made from oil. They are also using this same technology to switch to inorganic materials. And of course, as cars get smaller, they become more fuel-efficient and so need less gasoline and diesel.

Meanwhile, on the supply side of the story, shale-oil production costs will continue to fall in the short term at least, making it easier for these producers to tolerate low oil prices. It was clear from late 2014 that there would be strong motives for this to happen.

It was equally obvious from late in that same year that OPEC, led by Saudi Arabia would maintain its market share strategy.

Now we  also have the reintroduction of Iranian production following the lifting of sanctions.

The US Federal Reserve looks set to raise interest rates today for the first time since 2006. The resulting stronger dollar will mean cheaper oil. Higher US borrowing costs will further expose the faultiness in the global economy. This will again mean cheaper oil.

So where do we go from here? $25 a barrel oil before the end of the year or in Q1 2016? Perhaps even lower? This is perfectly possible until markets bottom out.

This means chaos in chemicals and polymer markets because until the oil market bottoms out, nobody will know the true extent of real demand. We will instead be constantly misled by the inventory destocking and restocking process.

Longer term, in a new Study we evaluate three scenarios for oil prices:

  • $100 = Continuing tension – Further central bank stimulus takes place as economic recovery stalls, and geopolitical risk rises along with the potential for supply disruptions.
  • $50 = Comfortable middle – Stimulus policies prove to have worked, demand recovers, revived growth prospects and project cancellations create a balanced market.
  • $25 = Collapsing demand – Emerging markets submerge, and developed markets slow dramatically as stimulus-created debt has to be repaid.

You might choose to only plan for the “Comfortable middle”. This would be a major strategic error.


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