By Gary Smith
By Gary SmithOil Outlook for 2016: How low can the Brent crude oil price go?
Recent RAC predictions were that UK motorists could be in for an early Christmas present, with suggestions that petrol prices are set to fall to £1 per litre. To put this in perspective, the last time fuel was available at this price was the summer of 2009.
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Behind all of this is of course the collapse of the price of oil. This time last year Brent Crude was selling at the $75 mark – and in early 2012 that figure was above $120. The beginning of 2016 is likely to see it hovering around $40, with analysts predicting that we still haven’t seen the bottom yet.
The last 18 months has seen a perfect storm for oil prices: weak demand coupled with overproduction, driven in no small part by a standoff between the US and OPEC countries. It boils down to this: if producers keep on pumping at the same levels, then prices will continue to slide. But there comes a point where individual producers are priced out of the market and those economies that rely on oil revenue to stay afloat are compelled to say, “Enough is enough”. The question is are we there yet? The answer – at least on the basis of recent OPEC pronouncements – is no.
Here’s an outline of the current landscape and an indication of what to look out for over the coming year…
The great supply side battle: OPEC v US Shale
Up until about a decade ago, the only way to deal with depleting oil reserves was to locate and extract from harder-to-get-to seams. This would push up the price which in turn would temper demand which (in theory at least) would keep the price relatively stable.
But US producers managed to hone a new way of doing things: combining horizontal drilling with hydraulic fracturing to reach expansive yet shallow reservoirs effectively and to ‘ease’ oil out from among rock formations. US production was dragged from the doldrums to the extent that by 2013, the country was exporting more than it was importing for the first time since 1995.
Certainly when compared to the major OPEC players, the US is not a significant oil exporter. The issue was that as domestic production increased, reliance on overseas imports was cut back dramatically. The initial response on the part of OPEC consisted partly of an attempt to offset reduced US demand by increasing market share in Europe and Asia. For instance, Saudi Arabia now ships crude to Poland and Sweden, undercutting Russian suppliers. But mainly, OPEC’s strategy has consisted of a deliberate policy to keep pumping out oil at the same levels in an attempt to price the frackers out of the market.
This strategy has two big flaws. The first is that from China to Europe and right across the globe, demand is flat, and so OPEC’s attempts to compensate for the US situation by looking elsewhere have had very limited success. The second problem is that the nascent fracking industry has shown a lot of resilience in the face of attempts to price it out of the market. In contrast to the big unwieldy operations in the Middle East, fracking is flexible; with the companies involved demonstrating the ability to reduce, halt and then ramp up production again relatively quickly in response to a volatile market. Despite the best efforts of OPEC, fracking is here to stay.
December 2015: OPEC’s latest response
The outcome of the most recent OPEC meeting at the beginning of December was enough for Brent crude to fall below the $40 benchmark for the first time since 2009. With members failing to reach agreement on an oil production ceiling and with the world currently producing up to 2 million barrels per day more than it consumes, some commentators, including Goldman Sachs predicted that prices could fall further – to as low as $20 per barrel.
Although the medium-term outlook is bearish, traders should look out for signs likely to trigger short-term price fluctuations. Factors likely to trigger movement in 2016 include the following…
Iran goes online
If all goes to plan, the full lifting of sanctions on Iran will come into effect early in 2016. Indications are that the Iranians intend to raise supply by at least 1 million barrels per day; representing a one percent hike in global production. This is a planned process and as such, is likely to have been priced in already. However, traders should look out for indications of any supply or production problems with the potential to reduce output estimates. Any barriers to Iran coming fully online could be enough to trigger a modest, and likely short-lived, upward spike.
Oil storage capacity
On the one hand, China’s slowing economy is a major driver behind the current situation. On the other, China’s policy of stockpiling oil for its strategic reserve is one of the main factors keeping a total price collapse at bay. But once stocks are at full capacity, this policy of stockpiling necessarily has to be reined in. Current indications are that stockpiling will taper off in late 2016. Look out for any indications that China is going to change course earlier than this as a negative sentiment.
Internal economic and social pressures in OPEC countries
IMF estimates suggest that Saudi Arabia and the Gulf States will see their revenue drop by $300 billion in 2015. The lower the price-per-barrel, the harder it is for oil-reliant states to maintain their physical and social infrastructure – not to mention defence spending against the backdrop of ongoing regional turmoil.
Ultimately, OPEC needs higher oil prices, and traders should look out for signs of domestic pressure within OPEC countries, sufficient to cause members to get their heads together, agree production limits and trigger a change in direction.
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