Oil Prices Caught Between Two Scenarios

Posted: Feb 13, 2015 12:01 AM

Oil prices have commenced a trading pattern in 2015 similar to that of 2008/2009, following the last parabolic decline. They’re waffling back and forth, searching for a trading base. At least as of the date of this article (things change very quickly in the commodity pits) there’s not the rush for the door we’ve been witnessing since prices started to break down in July 2014.

The pundits are lining up, mostly forecasting a continued bearish scenario. Some of the recent comments coming from crude oil analyst Jeffrey Currie from Goldman Sachs saying oil prices stay down because of oversupply that he sees no end. Currie usually shuns the media, but has appeared on CNBC twice in the last two weeks, which causes one to wonder what’s behind his sudden fondness for the financial press.

Citigroup and their top analyst Edward Morse weighed in with the most bearish outlook on the street, citing $20 per barrel could be possible before an oil price base is finally established. Pierre Andurand, who runs a $400 million energy-focused hedge fund, said prices could stay at these levels for up to six months. Anurand was accurately bearish last summer when prices began to fall, and his behemoth fund was up almost 40-percent last year as a result.

All the aforementioned have been positioned on the short side during the drop, and very well may be deploying some old-fashioned jawboning to run prices back down so they can profitably close out any lingering bearish trades.

That’s in sharp contrast to some of the industries biggest giants who feel that the decline in new investing in oil and gas projects is setting the stage for a supply shortage sooner than Wall Street is expecting. Among those most vocal on the upside include Continental Resources CEO, Harold Hamm, legendary Texas oilman, T. Boone Pickens and OPEC’s Secretary General, Abdallah el-Badri, all who have recently predicted prices above $100 per barrel in the short to mid-term.

One thing Wall Street doesn’t seem to be factoring is the decline curve. In shale wells, the bulk of the profits occur within the first several years. This is known industry-wide, and new drilling projects always factor this into their profitability forecasts before any company plans on investing in oil and gas projects. It appears that either Wall Street feels U.S. shale production is so prolific that declines won’t be felt anytime soon, or they are simply choosing not to include it as a main factor in their formulas.

Rigs are coming down at the fastest clip since 1985 and that will certainly help form a top in supply numbers. When that top will firmly be in place is still yet to be seen, or accurately forecast.

Is it possible that production continues to outpace demand by a wide enough margin to suppress prices? That scenario is certainly possible. Global supply increases could come from a number of regions, including South America, Africa, Libya, Iran, Iraq, Russia, and Saudi Arabia, to name a few.

Is it likely? Probably not. OPEC countries all need oil prices substantially higher than they are now to balance their national budgets. Venezuela is facing bond payments in March and October that many are suspicious whether one, or both, will be met. Russia is bleeding in red ink so bad that Standard and Poor’s downgraded their bonds to junk. The world is simply not set up to operate fiscally at current prices.

Consumers were enjoying the lowest gasoline prices in six years until the United Steelworkers decided to strike. Unfortunately, layoffs and lower spending is the 2015 theme, certainly in the upstream sector of the energy sector. Many families are feeling the pain of these prices first-hand, and are making necessary adjustments. Drillers, suppliers and service companies are all tightening belts internally and passing the savings on to their customers as enticement to keep as many rigs working as possible.

Now, comes the news that the President is going to ask Congress for official authority to go to war against ISIS, which could add instability to an already nervous market.

Certainly, the one ingredient that will answer all these questions is time.

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