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Low Oil Prices: Are They Here to Stay?

Oil prices seem to be routinely finding new lows lately. We are getting used to price below $30 per barrel and there are forecasts of $20 oil coming. Are low oil prices here to stay? Is oil due to rebound sharply to $80 or even $100?

Let us first summarize the reasons for current low oil prices:

  1. Oil production surplus. The current oil surplus at the end of 2015 was estimated as 1.6 mln. barrels per day. The surplus production means oil market supply exceeds demand, that automatically drives oil prices down.
  2. Global economic slowdown. Slowing in the economy means reduced oil consumption, i.e. less demand. Slowdown of Chinese economy is the major contributor.
  3. Coming increase in oil supply due to Iranian oil. As sanctions are removed, the additional oil supply will compete for the markets, possibly driving the prices lower.
  4. Unwillingness of the OPEC member countries to reduce production. Intentional overproduction of oil drives prices lower.

If we neglect possibilities of escalation of political or military tensions in the Middle East, the global picture looks as follows:

  1. Economic slowdown will continue for several more years at least. There are no perspective of prompt recovery in Chinese economy. Slow economy means that the demand will stay at current level or decrease. => Low oil prices!
  2. Iranian oil will add supply to the market. Huge possibility of oil being intentionally sold at discount prices exist. => Low oil prices!
  3. Proliferation of alternative energy production. It is unlikely to happen within the next few years, but let’s still list it a factor. (I can argue that if commercial thermonuclear fusion technology will finally be implemented, the effect on energy prices in all sectors including oil will be dramatic.) => Low oil prices!
  4. Latest increase in oil and gas production was partially driven by shale oil and gas technology. The price of shale oil production in most areas is above $30 per barrel, in some places reaching up to $60 per barrel. Oil companies are continuing production at loss, in order to keep their market shares, but if the prices will stay low for too long, they will be forced to shut down the unprofitable wells. Less production. => Higher oil prices!
  5. Growth of world population increases the demand for oil approximately by 1.2 million barrels per day per year. If the production does not follow, the oil may becomes scarce. => Higher oil prices!

The listed factors linked to oil price growth are likely to evolve slowly, but inevitably. Therefore, oil prices are not due for fast rebound, but will grow slowly as the oil production surplus evaporates. The growth in prices will continue until higher prices will justify reopening and expanding production of more expensive oil. The market supply will increase until balance with the demand is reached, and the price will stabilize at a new higher level. The price growth may not happen this year, but it is likely to go up in 2017 after the market is adjusted to lower demand.

 

The post was inspired by the MarketWatch.com article “This is how the oil rout’s ‘endgame’ might play out” by William Watts.