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Why crude oil will average $80 a barrel in 2015

Business

British banker and politician Nathan Rothschild once said: “Buy when there’s blood running in the streets.”

And blood is certainly spilling in the streets of the oil and gas industry. The North Sea benchmark, Brent crude, closed at $70 a barrel on Friday, declining by 40% since June. Today it’s trading at around $71.

Energy stocks around the world lost $500 billion of market value in the past week, while many oil-exporting countries will face budget crunches in 2015. Saudi Arabia needs Brent at $93 a barrel to balance its budget; for Russia, as high as $120 a barrel.

We have argued for lower oil prices since last year, due to these three factors: 1. The unprecedented increase in U.S. oil production due to more efficient horizontal drilling and hydraulic fracturing technologies; 2. Weak demand growth in developed countries; 3. The imminent slowdown of the Chinese economy, which has accounted for a third of the world’s oil demand growth in recent years.

Gasoline prices will decline further, encouraging car travel and higher-than-expected U.S. crude-oil demand in 2015.

Some analysts are calling for even lower oil prices, but we believe oil’s recent decline is overblown. We believe oil prices are now close to a bottom, and that Brent crude will average $80 a barrel in 2015, for the following three reasons:

1. Global oil production will decline in 2015, with Brent below $70 a barrel

Despite the recent decline in oil prices, the Energy Information Administration (EIA) still projects global oil production will grow by 1 million barrels a day in 2015. U.S. oil production is projected to grow by 1.1 million barrels a day, while Brazilian and Canadian production together will grow by 200,000 barrels a day, with North Sea and Saudi production declining by 300,000 barrels a day.

Most other analysts, such as those from Goldman Sachs GS, -0.11% are projecting similar production growth for 2015. Those projections made sense when Brent crude traded at $85-$90 a barrel a month ago. With Brent crude closing at around $70 a barrel, those projections are now outdated.

First, drilling for shale oil is very capital-intensive. Capital expenditures for U.S. shale oil and gas firms soared to $80 billion in 2013. More importantly, the industry experienced a $9 billion cash shortfall in 2013, after a $32 billion cash shortfall in 2012. That is, U.S. shale-oil producers have never been cash-flow positive and had to borrow the difference to fund their growth plans. With the recent decline in oil prices, shale oil producers will struggle to find fresh lenders willing to underwrite their growth plans. Because shale producers need to constantly drill new wells to maintain production, U.S. shale production will immediately decline if U.S. shale firms revise their growth plans. The EIA estimates that U.S. shale production will decline by 300,000 barrels a day in just 30 days if U.S. shale firms stopped drilling.

Second, most major U.S. shale-oil fields will lose money with Brent at $70 a barrel — after factoring in the recent 2% to 3% rise in debt-financing costs for new fields — unless they slash production by halting their drilling plans. Given the rapid depletion rates in “legacy” shale-oil fields, we believe that U.S. oil production will decline in 2015 if Brent stays below $70 a barrel, thus putting a floor on oil prices in 2015.

2. U.S. oil demand will surprise on the upside in 2015, with Brent below $70 a barrel

The EIA currently estimates U.S. gasoline consumption will decline by 20,000 barrels a day next year, due to improving fuel economy and anemic highway-travel growth. This assumption may be right when Brent crude traded at $85 to $90 a barrel, but not with gasoline prices now at their lowest levels since 2009. In fact, AAA estimates that automobile travel over the Thanksgiving weekend (November 26-30), was up 4.3% from last year, with 41.3 million Americans traveling more than 50 miles from home by car. This amount of Thanksgiving driving is the highest in seven years, and the third-highest since AAA began tracking Thanksgiving travel in 2000. If Brent stays below $70 a barrel, U.S. gasoline prices will decline even further, thus encouraging more automobile travel and higher-than-expected U.S. crude-oil demand in 2015.

3. The ECB’s 1 trillion euro quantitative-easing policy will support oil prices

The ECB’s vice president and second-in-command, Vitor Constancio, is now on record for advocating a 1 trillion euro quantitative-easing policy to begin as early as the first quarter of 2015. With the eurozone’s inflation rate now at a five-year low (and expected to fall to zero due to the recent decline in oil prices), we believe the argument for a quantitative-easing policy in the eurozone is compelling. We expect the ECB to purchase 1 trillion euros of the eurozone’s sovereign bonds (including those of Greece) over the next two years, to begin after its Jan. 22, 2015, meeting. This would improve the health of European banks’ balance sheets, which would encourage lending and improve the region’s economic and inflation outlook. An improved outlook in the eurozone will boost crude-oil demand and prices as well.

We are thus bullish on crude oil in 2015, and expect Brent crude oil to average $80 a barrel in 2015. Investors who want to go long on oil could consider the following ETFs: United States Brent Oil BNO, +2.29% which tracks the spot price of Brent crude oil, and Energy Select Sector SPDR XLE, +0.35% which tracks the performance of all energy stocks in the S&P 500 Index.

Disclosure: Neither the writer nor his firm, CB Capital Partners, holds shares in BNO or XLE.

Henry To, CFA, is partner and chief investment officer at CB Capital Partners. Established in 2001, CB Capital Partners is a global financial advisory and investment firm headquartered in Newport Beach, Calif., with an office in Shanghai and an affiliate office in Mumbai.

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4 Comments on "Why crude oil will average $80 a barrel in 2015"

  1. Plantagenet on Mon, 1st Dec 2014 6:35 pm 

    Oil stocks still have farther to fall, IMHO. Many of the smaller oilcos who are dependent on fracking hedged their production, pre-selling at $90-100/bbl, so they aren’t even seeing these low oil prices yet.

    Wait until Venezuela goes bankrupt or something similar happens. That would be a good buy signal.

  2. redpill on Mon, 1st Dec 2014 6:56 pm 

    “The ECB’s vice president and second-in-command, Vitor Constancio, is now on record for advocating a 1 trillion euro quantitative-easing policy to begin as early as the first quarter of 2015.”

    And to this, Germany says?

    And on Venezuela:

    “I basically have to send patients to other hospitals,” she said. “But patients have to go to a lot of clinics and hospitals before they find the medical supplies they need for their care. I feel very sorry for my country.”

    Experts predict the situation in Venezuela will worsen as early as the first half of 2015.

    “It will be a year of extreme scarcity,” Venezuelan economist Angel Garcia Banchs said. “What’s coming to Venezuela is chaos that will probably lead to barbarity and people looting. ”

    The state of the Venezuelan economy is the result of years of economic mismanagement that the government, for years, was able to cover up by pumping oil revenues to support its populist policies. But this was when oil was at more than $100 per barrel, and despite declining oil production in Venezuela, revenues were enough to keep people happy”

    http://finance.yahoo.com/news/venezuelas-future-barbarity-people-looting-165018511.html;_ylt=A0SO8x.oDH1UwoAAn.RXNyoA

  3. redpill on Mon, 1st Dec 2014 7:06 pm 

    Also in todays news:

    “In Venezuela, the bolivar has hit new lows against the dollar, falling to around 155.8 per dollar on the black market Monday — a 50 percent drop in just the past month. The plunge further widens the gap between black market rates and the official exchange rate, which stands at 6.29 bolivars to the dollar. Meanwhile, a 15 percent minimum wage hike went into effect Monday to combat additional inflation, and Venezuelan bonds plummeted to a five-year low as investors fretted about a looming default.”

    Dang, that is a scary drop in the unofficial exchange rate!

  4. shortonoil on Tue, 2nd Dec 2014 7:13 am 

    We are thus bullish on crude oil in 2015, and expect Brent crude oil to average $80 a barrel in 2015.

    Bullish may be the wrong adjective to use for oil prices in this case, but their 2015 price of $80 for Brent will be pretty close. Our model, which has had a 4.5% margin of error over the last 53 years, puts the 2015 WTI price at $77. 2016 at $66, and 2017 at $54.00:

    http://www.thehillsgroup.org/depletion2_022.htm

    We expect all liquids production to Peak in 2016 when shale goes into rapid, terminal decline.

    http://www.thehillsgroup.org/

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