Saturday, February 6, 2016

Barron's Cover: "Here Comes $20 Oil"

This is such a tricky time in the oil markets.
On the one hand, production is still larger than consumption by a significant margin:
On the other hand there are so many bets on the short side that any change in psychology can result in a 10% daily up-move as we saw on Feb. 3.

Here's Barron's:
Oil could fall as low as $20 a barrel in the first half of this year, recovering to $55 by year end. That could help drive stocks, which have closely followed oil prices, much higher.

Oil bulls, take heart. The last leg of the bear market that began in mid-2014 is probably in sight, as marginal producers fall by the wayside. Supply cutbacks should bring a rebound in the price of crude by the second half of 2016. 

But before a rebound, West Texas Intermediate crude will probably continue to fall, perhaps as low as $20 a barrel, before vaulting to the mid-$50s by year end.

Stock market investors can also take heart. The stock indexes have been closely correlated with oil of late, moving up or (mostly) down, as the price of crude has gyrated. This perverse pattern has persisted even though the overwhelming majority of global companies benefit from cheaper crude, since they buy the refined products to help run their operations.

It’s true that many oil exporters are in emerging market economies, and low oil prices have slowed their economic growth and put a dent in their sovereign wealth funds. Beyond this, stock traders may be subscribing to the misguided belief that low oil prices are signaling imminent global recession.
Our expected recovery in crude by the second half of this year will, therefore, probably bring a recovery in equities. And perhaps even before then, stock traders might wake up to the fact that the bear market in oil has mainly been reflecting a world awash in black gold.

While global weakness on the demand side has played a part in the buildup of excess supply, it has been weakness in the rate of growth, not an outright economic contraction. A further slowdown in global growth, especially from China, will also play a role, but here again, the supply side will dominate, as cutbacks in production bring a rebound in prices. 

Barron’s predicted $75 oil in late March of 2014, when crude was trading above $100. But the market soon overshot our contrarian forecast, as the slowdown in global growth curbed the growth in demand. We followed up on that story repeatedly, lowering our sights to $20 a barrel a year ago (see chart below).

WORLD CONSUMPTION OF OIL has held up relatively well. It rose in 2014 to 92.8 million barrels a day from 2013’s 91.9 million, a below-par increase of just 0.9 million barrels. Consumption in 2015 rose to 94.5 million, for a relatively substantial rise from 2014. But, of course, that was due mainly to the price plunge that made oil dirt cheap. 

For 2016, in no small part because of the expected economic slowdown in China, Citigroup’s senior energy analyst Eric Lee projects below-par oil demand growth of one million barrels a day, to 95.5 million.

The supply side, then, has been the main driver of the oversupply that has wrought the bear market. And nowhere has the supply-side revolution been more dramatic than in the U.S. As recently as 2010, the U.S. produced 5.5 million barrels a day of oil. Due to the advent of hydraulic fracturing, or fracking—the extraction of oil from shale—production jumped to 8.7 million by 2014. In 2015, production set another record, at 9.7 million....MORE