The crude oil price was over $100.00 per barrel a year ago, and it might soar back that high again. Market news outlets are filled with analysts discussing why the oil price forecast is likely to head south, but what about the factors which could push oil prices up?
Before I go any further, it’s important to clear up a general misconception which seems to plague media reports on the apparent oil price collapse.
Demand for crude oil itself isn’t actually shrinking, or even stagnating. On the contrary, data shows that demand for oil and its derivative refined products is at its highest point in history. (Source: EIA, last accessed September 10, 2015.) The real problem, as I’ve written about time and time again, is the excessive oversupply as a result of record production.
So while oil demand growth from emerging large economies such as China, India, Brazil, Indonesia, and Nigeria is less than forecasted only a year ago, it’s not receding. (Source: CNBC, last accessed September 10, 2015.) In fact, a slight reduction in global production in the range of one to two percent would be enough to send the oil price hurtling upward.
But demand is lower than expected and producers are pumping more out of the ground than ever before. That’s what got us into this mess.
Chart courtesy of www.StockCharts.com
Now what could rebalance these disconnects between supply and demand and correct the oil market?
There are several factors that could come into play in the next 12 months and give uplift to the oil price. I’m not talking about black swans here such as a violent economic collapse or prolonged Chinese stock market crash.
Imagine one or a combination of the following scenarios:
First, despite all evidence to the contrary, demand could show unexpected growth. Economic forecasts have been wrong before, and the influence of mass buying and selling cycles on commodities markets has a way of turning short trends into an avalanche of demand. (Source: Financial Post, last accessed September 10, 2015.)
Imagine a short-term reduction in supply. It’s not entirely out of the realm of possibility, given the constant calls within OPEC itself to coordinate a slow and deliberate production pullback. (Source: Bloomberg, last accessed September 10, 2015.)
Indeed, this is the most likely scenario. Most analysts recognize that a fundamental supply and demand imbalance is what caused oil to nosedive in the first place. That conclusion carries the implication that it’s only supply that will get us out of it, then.
Second, with several of the largest crude oil producers facing extreme fiscal pain from the oil price collapse, as well as the accompanying political pressure it has spawned, a slowdown in production, coordinated or otherwise, is all but inevitable from an economic point of view.
The primary contenders are Russia, Venezuela, Nigeria, and Brazil, whose economies are heavily dependant on oil exports. (Source: Bloomberg, last accessed September 10, 2015.) But even comparatively wealthy oil giants with large sovereign wealth funds such as Saudi Arabia and Norway are feeling the pinch, and are now having to dip into savings to cover budget deficits. (Source: The Wall Street Journal, last accessed September 10, 2015.)
Whether through a coordinated effort from OPEC, or some combination of the oil cartel and rivals such as Russia, production will at some point have to be throttled back if the current low price environment continues.
Sponsored Content: (Video) U.S. Government Censors Most Profitable Retirement Plan?
Third, the U.S. oil industry may come under such financial stress which will stimulate a production pullback. As more and more U.S. producers are running fiscal deficits and taking out loans to continue operations, hoping for a rise in prices, the flow of credit from financial institutions is beginning to dry up. (Source: Bloomberg, last accessed September 10, 2015.) Shale output is especially vulnerable to capital markets becoming averse to lending. The result will be bankruptcies and mergers and acquisitions, with production declines.
Finally, if the U.S. Federal reserve does not increase its interest rate, as some analysts believe, the gains made by the U.S. dollar could scale down and provide some relief. (Source: Fox Business, last accessed September 10, 2015.) Crude oil is denominated in U.S. dollars, which has hurt international oil importers.
What, then, can you expect from crude oil prices this year and into the next? The oil price will likely drop down even further, perhaps testing the $37.00 six-year low achieved in August, which is necessary to produce the kind of extreme financial pain which will bring on one or more of the above scenarios.
Whichever of these catalysts come into play, it’s going to be a volatile ride for oil in the next 12 months.