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$25/bbl oil – probably now only a question of “when”, not “if”

Oil markets
By Paul Hodges on 21-Dec-2015

Brent Dec15Oil prices are just $1 or so away from falling back into the $10 – $35/bbl range that has dominated most of history.

Thus we are now reaching a second critical moment in oil markets since Stimulus began in 2009, as the chart shows:

  • The first was the end of the Stimulus rally which ran until mid-August last year
  • It created the longest “flag” shape I have ever seen, ensuring a major move would occur when the pattern broke
  • Since then, the market has been moving steadily downwards, as it tries to return to price discovery mode
  • Many have tried to manipulate it back upwards, but after initial success they have been crushed
  • Now we have returned to the levels seen at the bottom of the market in 2008 – so which way will prices now go?

It is a critical question.  Brent closed on Friday night at $36.88/bbl.  The only support now left for prices is the December 2008 low of $36.20/bbl.  If prices fall below this level, then the Great Unwinding of stimulus policies will be complete as far as oil prices are concerned.

Brent Dec15aThis is why we are at the second critical moment.  Can prices hold at the December 2008 lows, or will they continue lower?  The second chart puts this recent performance in the historical context:

  • It shows that a break of the December 2008 low, will take us back into the price ranges established before 2005
  • Its as simple as that – we would be back in the long-term historical range below the black line
  • The lowest price seen during that period was $9.55/bbl in 1998 and the highest was $35.30/bbl in 2000
  • This why the December 2008 low is so critical – it effectively divides the 2 pricing worlds

Which way will it go?  My own view, as readers will know, is that we are seeing the oil market trying to return to its true role of price discovery.  Without the impact of policymaker stimulus over the past decade – first the subprime bubble, and then the central bank liquidity bubble – prices would never have moved higher.

But this supply of cheap and limitless cash did not only boost demand.  It also boosted supply, and so we now have an emerging energy supply glut.  This is pushing all energy prices lower.

US natural gas prices settled Friday night at $1.77/MMBTU, back at the levels last seen back in September 2001.  So if oil wants to compete with natgas, it needs to be close to its energy equivalent value to natgas at around $10.60/bbl (oil has around 6x the energy value of natgas).

Impossible, you will say.  But people have been telling me my price outlook was impossible, or mad, or stupid or a combination of all 3 descriptions ever since I forecast in August last year that oil prices would collapse.

Their mistake has been to believe in the false market created by policymakers – understandably, since it has now been running for a decade.  I, however, believe that the market is trying to return to its true role of balancing supply/demand fundamentals via price discovery.  Stimulus only postponed this development after December 2008.

Maybe policymakers will intervene again, or some major geo-political event will occur, and take prices higher.  If not, then I would argue it is only a matter of “when”, not “if”, prices will break back below $35.30/bbl and hit $25/bbl.

The next question is then how low they will go after that?  With the volume of oil in storage – land and floating – it would only take one major player to panic sell, and we could move down towards $10/bbl very quickly indeed.

My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments: 
Brent crude oil, down 64%
Naphtha Europe, down 55%. “Naphtha demand among European petrochemical producers is healthy on the back of strong cracker margins”
Benzene Europe, down 58%. “The wider economic landscape is still keeping some players uncertain about how the market will fare in Q1 2016”
PTA China, down 44%. “Chinese domestic spot prices mostly fell during the week on pressure from falls in crude oil and feedstock values”
HDPE US export, down 37%. “Ample supplies with little trading activity”
¥:$, down 18%
S&P 500 stock market index, up 3%