The Cure for Low Crude Oil Prices…is Low Prices

“The American Petroleum Institute (API) reported a significant 5.79 million barrel drop in U.S. crude oil supply, the biggest draw since December, 2016. This comes after a reported 4.2 million barrel drop a week ago.” (5/9/2017)

Oil suffered a severe 75% drop in prices from late 2014 to the bottom in early 2016, at around $27 a barrel. At that time few believed a significant rally could occur. The stock market had suddenly become correlated with oil prices, and the sentiment was terribly negative, which is typically the case at major market bottoms. Here we are, a year and 3 months later, with oil trading near $48 per barrel. Most investors might consider that to be a pretty strong recovery in that period of time. However, recent weakness in prices from the past few weeks has been greeted by media pundits parading a never ending series of reasons of why the recovery in prices is over. They point to fracking meeting all of the world’s oil supply needs, and that is why prices will continue to decline. The wall of worry is solidly in place with regard to oil prices. Of course, once oil resumes its recovery on any sustained basis then the financial press will suddenly begin to focus on analysts that are now bullish or have turned bullish.

Reality & Uncertainty

The truth of the matter is that commodity prices are extremely difficult to predict on any short or intermediate term basis. Few if any are equipped to accurately forecast where oil prices will be one month, or one year, from now. For those of us that are investors with a longer-term focus, it seems best to ignore the barrage of news stories, stop thinking like traders, and focus on the long history of mean reversion in commodity prices. The cure for low prices is low prices and the capital market forces are clearly at work as a result of the tremendous drop in prices over the past few years – and not just in oil.

With all this in mind, we thought we would provide a few data points on the longer term outlook for crude oil which may have been lost in recent negative news coverage.

Facts

Global oil discoveries declined to 2.4 billion barrels in 2016, compared with an average of 9 billion barrels per year over the past 15 years. Furthermore, the number of projects that received a final investment decision dropped to the lowest level since the 1940s. (April 27, 2017, International Energy Agency)

Conventional oil production of 69 mb/d represents by far the largest share of the current global oil output of 85 mb/d. However, only 6.5 mb/d come from liquids production from the US shale plays. “The key question for the future of the oil market is for how long can a surge in US shale supplies make up for the slow pace of growth elsewhere in the oil sector,” said Dr. Fatih Birol, the IEA’s Executive Director. (April 27, 2017)

US production is up 327,000 barrels a day from last year and that is a small part of the Organization of Petroleum Exporting Countries (OPEC) 1.2 million barrels per day cut and does not even cover the 558,000 barrels per day non-OPEC cut. (May 1, 2017, The Phil Flynn Energy Report)

“Oil companies’ lean investment over the past two years, as prices struggled, could trigger a return to demand outstripping supply and a sharp rise in pricing volatility by 2020″, the International Energy Agency said in its five-year oil market forecast. (March 7, 2017)

US shale oil alone cannot meet the world’s growing demand for crude. Chevron CEO warned, “…ultimately oil fields decline, and we’re going to need all sources of supply, including the shales, but also deepwater and other sources around the world,” he said. (May 1, 2017, CNBC)

Bullish Views

Bill Strazzullo, Chief Market Strategist at Bell Curve Trading — who correctly called for Crude’s plunge to the $30 range back in 2013 — said oil could be on the verge of a massive rally that would send the commodity to levels not seen in three years. “I think over the next [few years] it’s not out of the question that you push $80- to $90.” (May 5, 2017)

Pierre Andurand, who shot to fame in 2008 by correctly predicting the spike and subsequent fall in the oil price from a record $147 a barrel, correctly forecasted that oil prices would trade close to $25 in the first quarter of 2016 and then correctly forecasted late last year that Brent Crude Oil would trade around $60 a barrel by the end of 2016 recently said, “I think oil prices are likely to recover to around $70 … I think the market will switch to backwardation – sustainable backwardation – by late summer and that will bring the next wave in oil prices.” (March 31, 2017, CNBC)

Alan Konn