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Commodity Specialist

Oil price, where are we headed?

This article is an overview of the events occurred in the oil market over the last months, and a possible forecast of what might happen to oil price in the near future.

In particular, since August 2014, several factors have pushed the price per barrel down from $120 to almost $45. Why was that? Firstly, the shale boom, which led to an increase in oil extracted. Secondly, a slowdown in the economy of major importers, e.g. China, that decreased their demand. Lastly, the strengthening dollar. In addition, the OPEC, which made its intention clear, by saying that: “it will tolerate lower prices in order to do to shale firms’ finances what fracking does to rocks” (source FT). In fact, Saudi Arabia, the main player within the OPEC, wanted to keep its status of main oil producer. It must be said that the oil industry heavily relies on capex (e.g. to research new oil fields, to cover the fixed costs required to drill wells…), which are mainly funded through bonds. This business model has become highly risky, considering that the American shale oil can cost up to 150% more than the one extracted by the Saudis, whose main goal has become to kick the Americans out of the market, in order to defend their market share, by keeping production steady during a period of decreasing prices.

Consequently, capex has been decreased (in Canada, according to the FT, capex will decrease by 33% in 2015), projects have been put on hold or even shut down (especially in Canada, Norway, and in the Artic), and some shale firms have started facing default. In addition, layoffs have increased, and a storage technique called Fracklog, i.e. delaying extraction of oil from wells already drilled but not yet productive, has been introduced by the Americans in order to avoid being forced to sell at this low price.

So what can we expect over the next months? As of today, Brent is trading at around $65 a barrel. Keeping in mind that it is estimated that a price below $50 is considered unsustainable for the shale industry, and a sustained price above $65/$70 is considered profitable, it seems that the Saudi’s plan is to keep prices between $55 and $65 by controlling production. If prices increase at more than $65, the high inventory levels can cause prices to go down again. In addition, it still must be understood what might happen if the ban against Iranian oil will be lifted in the short run.

In conclusion, I expect oil to trade around $63/$66 in the short run, with a negative outlook for the following months.

Skand Narang, Incoming J.P. Morgan Intern




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