How low will oil prices go this autumn?
Posted on 05 July 2010 with 1 comment from readers
With global financial markets trending lower since mid-May and forex markets now resembling 2008 pre-crisis, the oil market looks set for a rough ride over the summer, and could drop below the low of December 2008 of $33 a barrel.
Nothing is certain in this world but headlines like ‘Soft oil market seeks direction’ in the Gulf News today are pretty ominous. Oil prices have been very volatile over the past month or so, which is exactly consistent with a change of direction to the downside.
Market crash
If the global financial markets go into another free fall, oil will follow as it did in 2008. Some chartists see a third and final wave to the bear market since 2000 with stocks and commodities going oversold to the downside and below the lows of 2008-9.
It is much harder if you try to read the oil market right now from fundamentals. Oil demand has almost recovered to the levels of 2008 with Opec crude demand around 27.7 million barrels per day.
That said crude stocks are above the five year average, and Opec production is running at 29.4 million barrels per day. Supply in excess of demand usually points to lower prices, and it is a fair conclusion that speculative demand is the factor supporting the oil price at its current level.
Take that away in a financial market rout and the oil price will tumble. Another factor supporting the market has been the growth in car sales in China which now buys more cars annually than the United States. Rising car ownership supports the price of the stuff that powers the engines.
Tracking stocks
Not surprisingly then oil traders say ‘everything depends on the Dow Jones’, and indeed the correlation between oil prices and the stock market has been unusually close recently.
For the US stock market is both a proxy for fundamental and speculative demand for oil. If it falls so will the oil price.
Whether the oil price would then rebound as fast as it did in 2009 is another thing. And given the supply constraints and declining reserves this might prove an excellent buying opportunity for all investments related to oil and gas. The oil chart below, on the other hand, looks more like a classic head-and-shoulders, pointing to a long period of lower prices:
1 Comment posted by readers:
Any discussion about oil prices over the next decade must include an attempt to quantify emerging economy demand as an important driver at the margin. Here is a simple thought experiment using Chinese demand:
- China moves from 3 bbls/person/year to the South Korean per capita consumption level of 17 bbls/person/year over the next 30 years
- No peak in global production
In next 10 years we must find 44 million BOPD:
- 26 million BOPD to maintain supply – 30% of current production, almost 3 times Saudi Arabia’s output
- 18 million BOPD to keep up with demand – 22% of current production, almost 2 times Saudi Arabia’s output
If you superimpose peak production on top of this demand profile using the following parameters oil prices would increase approximately 250% in real terms over next 10 years:
- Oil demand elasticity of -0.3
- Current production 84 million BOPD, current price US$ 80
- Peak production 100 million BOPD
- Post peak decline rate of 3-4%
If you want to try the model for yourself using your own assumptions it can be found at Petrocapita Income Trust: http://www.petrocapita.com/index.php?option=com_content&view=article&id=128&Itemid=86