Oil Prices: This Could Send Crude to $40.00 per Barrel

Oil Price Drop 40 BarrelDon’t look now, but $40.00 oil may soon become a reality.

Crude oil prices skidded eight percent on Monday July 6th—the biggest single-day decline in more than three months—as oil oversupply fears continue to spread among investors.

As investors try to sort out whether the global oil market has stabilized from a historic collapse, some elements suggest that the outlook for oil prices is only getting gloomier.

Here’s why.

China May be Facing an Economic Slowdown

Economic growth in China, the world’s second-largest economy, is grinding to a halt. Sadly, the economy grew at its slowest rate in the last several years in 2014. The growth rate was around seven percent, compared to rates of 10% or more a few years ago. (Source: World Bank, last accessed July 7, 2015.)

The International Monetary Fund (IMF) has predicted that China’s gross domestic product (GDP) will grow at only an annual rate of 5.9% over the next six years.

On top of that, Chinese stock markets have tumbled over the past few weeks. All evidence suggests that the Chinese economy has been slowing down; the turmoil in the stock market is yet another sign of transformation to the slowdown in economic growth for the Asian giant which is the second-largest oil consumer.

To put it more simply, if the second-largest oil consumer cuts back its oil demand, there would be an enormous pressure on energy prices.

The U.S. Dollar

The U.S. dollar and oil prices tend to move in opposite directions. Simply put, when the dollar appreciates, oil prices tend to decline, and vice versa. Over the past few months, the dollar against other currencies appreciated significantly. There are two reasons that caused the greenback to rise.

First, the Federal Reserve has reportedly signaled plans to raise the federal funds rate after being kept near zero. According to policymakers, September seems to be the most likely month.

Second, the crisis in Europe sent the euro down against the greenback, pushing investors to seek a safer currency. This encourages investors to become more interested in buying dollars.

The Situation in Iran

Iran is nearing a historic nuclear deal with the international community—and that’s scaring the oil markets. Over the past two days, oil prices dove below $51.00 a barrel for the first time since April.

As it stands, sanctions currently limited Iran’s ability to sell oil, and have cut Iran’s exports to just over one million barrels a day. Sanctions were imposed on Iran by the U.S. and the international community in 2010, targeting Iran’s economic activities.

Oil is believed to make up 80% of Iran’s exports. Iran is the third-largest oil producer in the Organization of the Petroleum Exporting (OPEC) cartel. Prior to sanctions, Iran was pumping about 2.8 million barrels per day.

Iran’s oil is more influential on oil prices than Greece’s crisis of a deal being announced; there are about 30 million barrels of Iranian oil in floating storage possibly ready to hit the open market. Imagine the oversupplied oil market trying to digest even more Iranian crude. To read more on this, see “Iran Deal Could Send Oil Prices to $35.00 per Barrel.”

The turmoil in the second-largest economy may have a potential risk for the overall global economy; therefore igniting the possibility of a reduction in demand for crude oil. In respect to prices, the rising U.S. dollar causes oil prices to become more expensive for buyers with other currencies. And finally, on the supply side, the market is already saturated. If a deal between Iran and the United States is announced, it’s not clear whether the market will be able to absorb the additional crude.

All said; there isn’t any glimpse of optimism that could help oil prices recover.