$20 is the new $40
SINCE the new year, the price of oil has surprised even the most bearish punters, plunging by 18%. On January 12th West Texas Intermediate (WTI), America’s benchmark, briefly dipped below $30 a barrel, its lowest level since 2003. The next day an incipient rally was undone by the news that American stocks of crude oil and petroleum products had reached 1.3 billion barrels, a new record. Firms are hunkering down. BP this week announced hefty job cuts; Petrobras, Brazil’s state-controlled oil firm, slashed planned investment.
Some blame factors other than supply and demand for turning increasingly bearish. For instance, Standard Chartered, a bank, said oil might need to fall as low as $10 a barrel before speculators concede that “matters had gone too far”. But it’s mostly guesswork. Such is the level of uncertainty that American derivatives contracts tied to deliveries in April imply an oil price of anything from $25 to $56 a barrel, according to official number-crunchers.
Neil Atkinson of the International Energy Agency (IEA), a forecasting outfit, finds lots in the physical oil market to be bearish about—particularly regarding consumption, which was one of the few factors supporting prices last year. The sell-off in oil in the past fortnight has occurred concurrently with a slide in the Chinese stockmarket and the yuan, which some investors think reflects weakness in China’s economy and hence in demand for oil. Though Mr Atkinson acknowledges that possibility, he thinks this risk is overplayed: figures on January 13th showed China imported a record 6.7m barrels a day (b/d) of oil in 2015.
The trouble, though, is that apart from India and a wobbly China, demand is not looking promising anywhere this year. Europe is unlikely to see a repeat of its relatively strong oil-demand growth in 2015. Although America’s economy continues to grow, tightening fuel-efficiency standards cap the upside. Drivers in the Middle East, where fuel use rose last year, are more likely to keep their cars off the road after their governments raised petrol prices or eliminated fuel subsidies altogether to shore up public finances. “There are now considerable uncertainties about oil-demand growth globally,” Mr Atkinson says.
Adding to the gloom, producers are not turning off the taps as fast as people expected. The latest rout stems from an OPEC meeting in early December in which the producers’ cartel abandoned output quotas. Saudi Arabia, which used to curb output to rescue prices, now refuses to play that role, and instead is bent on driving high-cost producers out of business. Saudi officials privately say that they expect the price of oil to rebound late this year or early in 2017 as global output begins to lag behind demand. The natural decline as fields are depleted saps production by at least 5% a year, they argue, even before accounting for the effects of reductions in new drilling by embattled oil firms.
But there remains huge uncertainty about how much Iran will export when UN sanctions are lifted, possibly in coming weeks. What is more, Mr Atkinson says, production continued to rise last year from high-cost wells in the Gulf of Mexico and Canada’s tar sands because, however much oil prices fell, operating costs were lower. “The habit of the industry is to keep producing for as long as you can. Anyone who blinks first is handing a lifeline to their competitors,” he says.
To be sure, production in America is falling, thanks chiefly to cutbacks by struggling shale-oil producers. With oil prices at $30 a barrel, America’s oilmen will have an even tougher task shoring up output by drilling new wells, and will face further pressure from their bankers to reduce borrowing. AlixPartners, a consultancy that advises troubled firms, says more will go bankrupt this year. It forecasts a funding gap of $102 billion this year between American oil firms’ projected cash flows and their interest payments and capital spending, up from $83 billion in 2015. It said the downturn “could be one of the most severe and prolonged ever”.
But however big the cutbacks, they are not yet enough to reduce the glut (see chart). Global inventories are at record highs, the IEA says. The Energy Information Administration, an American government agency, predicts they will rise a further 700,000 b/d before supply and demand begin to balance out in 2017.
It adds that storage at Cushing, Oklahoma, which can hold 73m barrels, is at record highs of 64m barrels. Brian Busch of Genscape, an industry data gatherer, says it’s a similar story in China, with ships carrying oil spotted waiting at anchor out at sea because storage tanks appeared to be full. Based on the high level of stocks, Mr Busch thinks it could take up to a year and a half before the bear market ends. The only certainty is, the quicker the oil price falls, the sooner that day will come.
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