Is the price of oil going up, down or staying the same?
In 2007 I was co-hosting a show with Jim Puplava, a financial expert and energy expert, and we were dealing with $100 dollar oil and being asked to predict, would it go up or would it come down. It was a 6 man panel including us and we all predicted it would either stay the same or rise further. Knowing history, and seeing the price crash of 2008 and the gradual rise back up to $100 and the dramatic drop to the low $30s yet again, why would anyone try to predict the price curve going forward. However, being a gluten for punishment I'll throw my 2 cents into the bucket and lets see where we end up.
In this latest slide we saw an unprecedented event precede the price slide. A major producer whose production had been in a free fall forcing them to become an importer of crude reversed course and began to increase production. That increase was far more than anyone expected and it sent ripples throughout the world of crude.
The reason is that once again, technology changed the playing field. With the advent of shale production US natural gas prices plunged and stayed down. As that technology has been applied to oil shales US production has soared, followed with a price drop.
I see two sides on this debate, and they are the same two sides we have seen argue oil prices since the very first barrel was sold on a global market. Those that see the price staying low and those that think it will rise. However, in the face of continued production levels from OPEC and increases from Russia, those that see the price rising are in the minority.
However, the price of crude has been rising steadily since the very lows seen at the end of 2014 and we are beginning to see data in the US that suggests this might have a reason. First is demand, low prices have spurred the largest consumer of oil in the United States to increase consumption. Cars are being utilized more than ever, in the US gasoline consumption is back to 2007 levels. Additionally the SUV is back on the best sellers list and even owners of hybrids, electric cars, and small fuel efficient vehicles are trading in for the larger vehicles.
Production is the obvious second reason for a higher price in the US. Shale production causes a very unusual production curve with first oil coming in at a high production rate followed by a steep decline and hopefully a long and sustainable lower production rate. We have been riding those higher production rates from wells drilled last year. But I don't think anyone missed the rapid decline of drilling rigs in the field. Over 50% of the land based drilling rigs in the US have been stacked. Operators are only drilling when they absolutely have to and conserving cash and renegotiating with banks and investors. The result of this is seen in the recent inventory drawdowns that occurred over the last four to five weeks.
Third, there is growing talk about letting US producers export crude. This one seems a little counter productive, if we are a net importer why would we want to export? Currently the US oil price is captured by the rate at which our refineries can accept crude and the amount of storage we have available. If we allow exports producers can increase the rate at which they drill and produce knowing that they can export if local buyers cannot be found. This would bring WTI pricing in parity with Brent crude which traditionally runs higher.
The fourth issue is war and conflict. With the fall of Libya, Syria in conflict, Iraq falling to ISIS and other Middle East producers feeling the struggle it maybe difficult for them to maintain production levels leading to shortages as demand increases globally.
Others will site growing demand in the East. With a Chinese growth rate of 7% or better they could be right. At 7% China uses more crude today than it did in 2010 when it sited a 10% rate of growth. Other countries in the East are continuing to grow as well and could put pressure of prices if production stagnates or is reduced.
All that being said there are equal or greater pressures out there that say the price is going lower, or at least not higher that cannot be ignored. The first being OPEC, which as we have said decided to defend market share rather than lower production targets. Indonesia has also recently joined the ranks of OPEC giving them more members. Additionally, non-OPEC producers are increasing crude, namely Russia. Should OPEC decide to offset the lower production rates coming from the US with even higher levels of production this would signal the market to remain low or go even lower.
Some of the warring producers could also find it relatively easy to increase production should conflicts be resolved. So if ICIS is successful in taking over Iraq and begins to increase exports of crude that would send the same signal. Also, lets not forget our friends in Latin America, namely Venezuela. Should PDVSA come under better management and be allowed to invest in production and better drilling practices we could see their output rise on proven resources.
Lastly, there is Mexico, a long time producer forced to live on anemic resources while its profits are used to run an inefficient government. Mexico recently changed the rules and is allowing investment in natural resources by foreign companies and NOCs. This could dramatically improve the forward curve for Mexican crude production.
What does all of this really tell us? First only a fool would try to predict the price of oil going forward. Second, if you only listen to one side of the debate you could easily find yourself on the losing side. Third, it might be wise to balance the portfolio with natural gas, at least that puts you into a position to take advantage of a growing global market and natural gas can be exported from the US even as we speak.