According to a draft report by the Organization of the Petroleum Exporting Countries (OPEC), oil prices will stay below $100.00 until at least 2025. In the most optimistic scenario, OPEC says oil will sell for around $76.00 per barrel in 10 years’ time. On the other hand, it also said crude oil prices could be as low as just $40.00 per barrel in 2025.
Either scenario is bad for the U.S. economy, as well as oil and gas producers.
Oil Rally in Jeopardy
OPEC, which represents 12 of the top oil-producing countries, said it expects oil prices to remain under $100.00 a barrel for the next 10 years. In the last few weeks, prices have rallied after hitting six-year lows in mid-March. But now there are worries of whether this rally will lose steam.
Oil prices tanked 60% after OPEC announced it was not going to cut its output last summer. While oil prices have rebounded slightly, they are still down 45% over last June’s highs. And there are fears oil prices could tumble even further if the U.S. and OPEC maintain their steady output.
Lower gas prices caused Americans to hit the road in record numbers last winter. Lower oil prices are good for the U.S. economy in the short run. It increases disposal income, which gives Americans more money to spend on things they like to buy.
However, in the long run, it could also decrease savings and reduce financial security. Lower gas prices could reduce the inflation rate into negative territory which could also force the Federal Reserve to actually cut its key lending rate. Unfortunately, a lower interest rate discourages people from saving their excess disposal income.
Basic Economics at Play in the Oil Market
Since oil prices started to decline last summer, the number of rigs drilling in the U.S. has fallen to multi-year lows. North Dakota state data shows 84 active drilling rigs in service as of Monday, May 11; the lowest on record in more than five years. In the prior week, there were 86 active rigs. In the same week last year, there were 108 active rigs. (Source: UPI.com, May 11, 2015.)
Now that OPEC has announced plans to maintain its production output and keep oil prices artificially low for the next decade, U.S. oil producers could get even more discouraged.
On top of that, a strong U.S. dollar and OPEC’s steady production will increase U.S. imports and reduce drilling here at home. This will translate into higher unemployment in the U.S. oil industry, putting the brakes on an already fragile economy. If crude prices continue to decline, U.S. oil companies will be forced to reduce costs, not just by cutting back on production, but also future projects, and research and development.
At a time when demand for oil is weak, increased supply from sources outside OPEC and the U.S. will put further pressure on oil prices. That said, geopolitical tensions in Yemen, the nuclear deal between Iran and P5+1 (United States, Russia, China, United Kingdom, France, plus Germany), and the growing threat of ISIS in the Middle East could cause oil prices to fluctuate.
In this uncertain environment, if the supply continues to increase and demand weakens, it will not be surprising to see oil prices remain at current levels. I suggest that investors pay more attention to the risk involved in taking a position in oil and gas companies than expected returns.