Has the Price of Oil Reached the Bottom of the Barrel Yet?
Analysts’ opinions have not been unanimous on the matter, but the evidence suggests that oil prices will get lower before they reverse the bearish trend, according to the Bank of Montreal (BMO). (Source: “Oil May Drop Under $20 In The Short-Term, But What Is Its Price Floor?” Zerohedge, December 28, 2015.)
“We believe that the weakness in crude oil prices reflects a combination of fundamental factors and financial flows. Fundamentally, there is simply too much oil,” states one BMO analyst. (Source: Ibid.)
Indeed, Canada’s Bank of Montreal hints that any suggestion of a price floor is unwarranted. The supply-demand imbalance could force oil down an uncontrollable chute, such that prices could “drop to $25, $20 or even $15, as some aggressive put buyers are speculating.” (Source: Ibid.)
Therefore, to the question of whether or not oil prices could go as low as $20, BMO answers a flat “yes.”
The only way to prevent oil prices from proceeding in a downward spiral toward $20.00 a barrel, or even lower, as BMO warns, is for a significant production cut to take place. BMO says that the global oil market will have about 920,000 bpd of oversupply in 2016. Nevertheless, this amount is based on current assumptions of year-over-year global demand growth of 1.2 million bpd, with Saudi Arabia, Iraq, and Libya holding production at their current levels, Iran gradually raising production over 2016, while the U.S. keeps its rig count levels. (Source: Ibid.)
Any change in one of the variables aimed at increasing production (the big concerns are Iran and Libya, the latter of which could easily increase production by several 100,000 bpd if it managed to reach political stability) would worsen the imbalance and make a mockery of even the most bearish floor predictions.
Crude Price Implosion Probable in the Near-Term
That, however, is just the beginning, warns BMO, because the situation is more complex. Indeed, while it would be impractical to propose an oil price floor in the short-term, in the long-term, an oil price collapse would not be “practical.” (Source: Ibid.)
BMO suggests that after the oil bears test various floor prices, which may go as far down as $20.00 or even $15.00 a barrel, Brent crude will start to find support at about $30.00–$35.00 per barrel. BMO suggests that at a price below that sustainability level, “companies would begin to shut-in production as variable production costs would exceed cash flow for some projects.” (Source: Ibid.)
In addition, BMO suggests that even at $30.00–$35.00, a range that’s close to current prices, the industry would find oil production unsustainable. BMO believes that “the industry requires a Brent crude oil price in the range of $40-50/bbl. in order to sustain production at current levels,” even if this depends on the type of resource. (Source: Ibid.)
For example, in situ oil sands projects, operators have sustaining capital of “roughly $6/bbl. whereas sustaining capital for a conventional onshore oil play is approximately $15/bbl. and for shale oil we [BMO] estimate that sustaining capital is approximately $18/bbl. Accordingly, at Brent prices below $50/bbl. we would expect global non-OPEC oil production to decline over time, recognizing that there would be an initial lag.” (Source: Ibid.)
BMO expects that companies will not invest in new projects aimed at increasing production until oil prices can deliver a return, a level that the Canadian bank envisages to be in the range of $60.00 to $70.00 per barrel. However, before oil can return to such price levels, BMO analysts believe it will have to drop further in the short-run.