Long winter predicted for oil as market rout continues

The oil market limped into the New Year still reeling from one of the most brutal years on record.

World benchmark North Sea Brent crude oil futures were up 14 cents at US$36.60 per barrel in thin volume on the final day of trading, but that was only just above the 11-year low of $36.20 last month, and it leaves oil prices down 68 per cent since the market rout began in June 2014.

There are few forecasters who see any quick respite, despite signs that the Saudi Arabia-led Opec policy of maxing out production to squeeze out higher-cost producers is gradually having the desired effect.

The impact on the industry was underlined by Fatih Birol, head of the International Energy Agency (IEA), the Paris-based energy watchdog for the major consuming countries, when he noted that industry investment had declined by 20 per cent last year (about $200 billion) and would decline again in 2016.

“We have never seen in the last 30 years oil investments decline two years in a row,” said Mr Birol. “If this investment decline marries with an uptick in oil demand, which may well be the case with the lower prices, we may see some surprises in the next few years.”

Opec, in its annual report, estimated that the industry had lost 150,000 jobs last year.

The rise in US oil production, which is generally seen as the biggest single factor that has led to the world oil glut, was curbed last year, albeit erratically.

In its latest weekly report last Wednesday, the US government’s Energy Information Agency (EIA) said that domestic oil production averaged 9.2 million barrels per day (bpd). That was up slightly from the previous week but the EIA encourages people to follow four-week averages and December’s average production of 9.18 million bpd was 40,000 bpd below November’s output.

The trend for production has been generally down since it peaked at 9.6 million bpd in June.

Both the IEA and the EIA expect US production to decline sharply this year, by about 500,000 bpd.

The problem for the oil market is the momentum of oversupply which means surpluses are still building, even if the rate is slowing.

This can be seen in the near-record level of commercial crude oil inventories in the US, which rose again last week by about 2.6 million barrels to above 487 million barrels. That was near the record posted last spring above 490 million barrels.

Worldwide inventories of crude have been building at similar rates and one of the beneficiaries has been owners of oil tanker vessels, the rates for which have jumped to seven-year highs as traders lease them to store crude in the expectation of selling at higher prices later on.

Most forecasts see a gradual rise in prices this year and long-dated futures reflect this. The futures contract for December 2016 delivery, for example, was at $43.57 yesterday, which means it can be profitable to buy cheap oil now, store it in ships and lock in the higher price for later delivery.

But most forecasters also see the market remaining under pressure this winter.

“The already oversupplied market now faces the imminent return of Iranian barrels and onshore storage capacity constraints look set to be tested in the first half,” concluded Ed Morse, Citibank’s chief oil analyst, in his end-of-year report.

The Morgan Stanley analyst Ruchir Sharma also foresees “a long winter” for oil, although his prediction that crude would trade between $35 and $70 per barrel “for many years” is a typically fluid forecast.

Goldman Sachs has been widely cited as forecasting oil dropping to $20 a barrel, although its report on the matter actually said: “While not our base case, the potential for oil prices to fall to [cost-of-production] levels, which we estimate near $20 per barrel, is becoming greater.”

Goldman’s actual forecast was for oil prices to average $45 per barrel next year, a revision of its previous 2016 forecast of $57.

As the high-profile hedge fund investor Steve Schwarzman noted at a Goldman Sachs investors conference in December, trying to predict oil prices is a mug’s game.

But one thing that most savvy investors are comfortable predicting is that the coming year will be as volatile as the one just past. Already, speculators have put on a record number of bets against oil prices by “shorting” the market, although that could as easily lead to a sharp rally in the new year as it could a sharp decline.

One of the more important implications of lower prices for fossil fuels, as Mr Birol pointed out, is that they could well encourage more oil, gas and coal consumption, which would undermine the policy pledges to curb their use at the climate change summit in Paris last month.

“After Paris, lower oil, gas and coal prices may well be a reason for some governments not to support the renewables which they badly need,” he warned. “If prices remain so low, this may well be a challenge for the governments to continue their support for renewables and energy efficiency.”


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