Here’s Why I’m Dialing Back My WTI Oil Price Forecast in 2016
If oil price volatility has done nothing else these last few weeks, it has proven that short-term rallies come and go but the downward price trend will continue. It was only a month ago that oil prices appeared to have finally hit a bottom following a catastrophic 60% drop in the crude price.
As the price of West Texas Intermediate (WTI) slipped well below $40.00 per barrel in August, investors began taking on more bullish positions in anticipation of a coming rally. The result was what now appears to have been a short-lived rally, with crude oil prices stabilizing around the $45.00 mark for most of September. North American crude appeared to be finally coming in from the cold, as data showing a decline in U.S. production and rig counts emerged. There was even an apparent willingness on the part of OPEC to discuss cutting back its production levels. (Source: “Rig Count Overview & Summary Count,” Baker Hughes web site, last accessed October 15, 2015.)
Bolstered by the confidence that only positive data can bring about, oil markets were thought to finally be taking off again, perhaps even returning to the heydays of $100.00 per barrel.
All seemed well, according to this narrative. Production level declines and rig shutdowns would take care of oversupply issues and credit redeterminations by financial institutions would weed out the unsuccessful energy companies that were unable to survive through the past year’s downturn in oil prices. (Source: “Can The Oil Industry Really Handle This Much Debt?” OilPrice.com, October 13, 2015.)
But there are additional factors that coalesced to provide uplift to crude oil prices. Broader global economic volatility in financial markets and currencies fed the anxiety, which put a stop to a U.S. Federal Reserve interest rate hike in September. The resulting weakness of the U.S. dollar helped prop up crude oil prices, as they are USD-denominated on international markets. Finally, we still have the ongoing conflict in Syria to consider, with the overlapping interests of Russia, the United States, and other parties threatening to spark a wider geopolitical conflict.
Despite these positive factors, oil prices only staged a minor rally this month. WTI prices briefly surged to more than $50.00 on October 9, hitting a three-month high before settling back down after the reality of our present situation had set in.
Chart courtesy of www.StockCharts.com
But what happened to the rebound?
No amount of favorable data estimates nor any number of times the Fed kicks the “interest rate hike” can down the road can make oil markets ignore a simple fact: there is too much crude oil and not enough demand.
The 10% surge in oil prices over a period of just days was simply market optimism gone amok. Investors briefly forgot about the current state of affairs in the energy sector. Crude prices, of course, began their precipitous decline earlier this week, settling back in.
What is likely to come is a market correction, where the profound imbalance between supply and demand will correct itself. This may occur slowly over time, with various fits and false starts along the way, or it could be precipitated quite suddenly by an economic or geopolitical event.
If events unfold according to the first—and more likely—scenario, then recent data from a variety of sources indicate it will take a year or more for market equilibrium to be reached.
The International Energy Agency (IEA) noted in its October report that global oil demand growth now sits at a five-year high. (Source: IEA, last accessed October 15, 2015.) Demand for crude will, in fact, grow by a projected 1.8 million barrels per day in 2015, which is an exciting figure until you get to the part where the agency reports it will taper off next year. Demand growth for 2016 is a more modest 1.2 million barrels per day according to the IEA, so this latest news should be treated more as a temporary blip than a new norm.
If you’re wondering why demand is expected to fade next year, you can blame global economic softness. The International Monetary Fund (IMF) revised its previous global economic growth forecast by 0.2% for next year, as China’s slowdown becomes more visible, Europe’s economies are flat-lining, and broader financial market volatility continues. When you combine this pessimistic context with slowing oil demand growth and the looming threat of Iranian crude production, you start to understand why investors have turned decidedly bearish on oil prices.
Much noise was made about the decline in non-OPEC production, especially in the U.S. with the IEA predicting a production drop of 500,000 barrels per day in 2016. This figure sounds promising, given that current global oversupply is in the range of two million barrels per day, but far less so when you take a look at OPEC production. The oil cartel released its September report, indicating that rather than pulling back production, it had continued to run red-hot with a 109,000-barrel-per-day increase for the month of September. (Source: OPEC, last accessed October 15, 2015.) Iraq continues to surprise analysts, as the war-ravaged country managed to add more than 80,000 barrels of oil per day last month.
The Energy Information Administration (EIA) corroborated the abovementioned reports, forecasting U.S. crude oil production to decline to 8.9 million barrels per day by next year. (Source: EIA, last October 15, 2015.) EIA data is perhaps the most bearish, predicting that WTI crude will rise to a half-hearted $53.57 per barrel in 2016.
The Bottom Line on Crude Oil Prices
OPEC, the EIA, and the IEA all concur on the inescapable fact that we will see a persistence of global oversupply in oil markets into 2016. The consensus opinions between these three organizations are that a market correction will occur as a result of dropping U.S. production and rising global demand. Private sector analysts are echoing these sentiments, with Goldman Sachs and Citigroup, among others, chiming in with bearish predictions on the crude oil price forecast.
The broader implication here is that we won’t be seeing oil skyrocketing upward anytime soon, barring the possibility of a black swan event. Crude oil prices may not fall as low as $10.00 per barrel, but there’s certainly a lot of downside from here.