Oil: The Ridiculously Simple Reason Oil Prices Are Going Lower

Oil PricesNo Upside for Oil Prices

Oil prices are caught in a death spiral with February’s West Texas Intermediate (WTI) oil landing at a 12-year low below $30.00 last week. Surprised? You shouldn’t be. Back in a November 2014 commentary on oil prices, when WTI crude was trading at $47.00, I suggested the following: “The reality is we will likely see $30.00 oil before $70.00 oil.”

Now, with oil prices falling to a two handle, there is talk about oil burning down to $10.00 per barrel.

I recall when oil prices were at $130.00 per barrel years ago and believing the love affair with the black sludge wouldn’t last.

China’s superlative double-digit economic growth, driven by overbuilding and lavish spending, was the major reason for creating the commodity supercycle that sent oil, copper, gold, silver, and other commodities skyrocketing on the charts.

But that was then. We all now realize China is facing tremendous hurdles to avoid a hard economic landing and whether it works is highly debatable.

The only thing for sure is that the hurting in China will bring about a major impact on economies worldwide, including the U.S., despite some who argue that what happens in China has minimal influence here. Those folks are clearly performing some voodoo analysis.

Oil Has More Negatives

The question now is this: how much more pain will oil companies and investors have to endure?

Goldman Sachs believes the price of oil can trade back at the $40.00 level sometime in the first half. The firm suggests a bull market for oil, driven by declining oil rigs and production, will inevitably lead to a global deficit in oil. (Source: “Goldman Sachs Sees Oil Bull Market Being Born in Today’s Crash,” Bloomberg, January 15, 2016.)

While I find the Goldman Sachs thesis interesting, I doubt oil will recover to $40.00 this year.

Light Crude Oil Chart

Chart courtesy of www.StockCharts.com

The fact is that there are simply too many negatives that will continue to hamper oil prices and cap upside moves.

The positive is that U.S. oil production continues to fall, as more than 1,100 rigs sit idle as of October 30, which will help with the supply glut. (Source: “North America Rig Count,” Baker Hughes, last accessed January 15, 2016.)

The problem on the prediction end is that OPEC (the Organization of the Petroleum Exporting Countries) continues to pump out oil, trying to drive the U.S. oil business into the ground. I don’t expect OPEC to change its strategy, even though many of the smaller OPEC countries are hurting, with Brent oil sitting around $30.00 a barrel.

Then there’s Iran. Oil will begin to gush from its fields in the second half of 2016, after the Iranian nuclear deal is in effect. The estimate calls for about 800,000 extra barrels of oil per day to flow into the global marketplace. I just don’t see who is going to buy this. (Source: “Iranian oil could send an already-saturated market back into a price nosedive,” QZ, April 7, 2015.)

Finally the demand side of the oil equation doesn’t play out for higher oil prices this year. As China continues to struggle, it will use less oil. The country recently increased its oil imports, but the feeling is that this is simply to add to its reserves at the lower prices. It’s like stocking up your pantry when pasta or canned soup is on sale; you’ll eventually use it, so why not save money when you can?

Ultimately I don’t see the thinking behind Goldman’s assessment for oil prices in the first half unless they know something I don’t.

Simply put, oil prices will likely hold in the $30.00 range or lower for the foreseeable future. That is, unless we see the underlying oil market metrics shift in favor of rebalancing the supply-and-demand equation.