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Michael Lynch: Is $50 Oil The New $100?

Michael Lynch: Is $50 Oil The New $100? thumbnail

The price of oil has seemingly stabilized near $50, raising the possibility that this is the new equilibrium or market-clearing price. At several points in the past year, prices seemed to be moving up or down, only to revert towards this new mean. To some degree, this implies that traders think that $50 is the sweet spot, and any deviation will bring in either buyers or sellers. Of course, at the same time there are those arguing prices might go to $20 when Iran starts exporting, or recover to $100 with the expected drop in shale oil production. And there are those who don’t make predictions but just laugh at those of us who do.

The reality is that prices could do all of the above, depending on geopolitical developments more than anything else. In particular, the potential for a supply disruption in December following elections in Venezuela would send prices scurrying upwards. More Middle Eastern violence, especially on or close to the Arabian peninsula, would increase the security premium on oil, although a new intifada seems unlikely to have an impact (unlike the last one, which elevated prices for a time).

But why $50? Why not $40 or $60? At the risk of being repetitive, it is as Keynes figured out a century ago, that the economics don’t determine the price, traders’ views of the economics do, especially in the short term. And arguably, there is a perception that a price too much below $50 would not be sustainable for any length of time, and a price too much above $50 would also be unsustainable. However, the mechanisms that would generate this in the market are different.

For low prices, there are only two routes for recovery (ignoring trader psychology). First, OPEC and/or non-OPEC producers decide to cut production. Second, oil production declines sharply because of low prices. The first is quite possible, but not until prices get well below $50, while the latter is more problematical: it requires oil production to decline due to non-investment, which means the change will be notably lagged. Operating costs in oil fields are typically a fraction of the total, and only the most marginal of wells is likely to be shut down in a price collapse.

Alternatively, traders might be factoring in the potential for further disruptions, that is, considering that the possibility of a supply cutoff from Venezuela—or elsewhere—might raise prices in the future. I don’t know if any traders have an explicit model incorporating such probabilities, but the brain can do much more intricate calculations than most computers. (Not necessarily correct, just more intricate.) The lower the price, the greater the probability of a supply disruption in the weaker OPEC members, which helps put a floor on prices.

On the up side, traders no doubt think that any serious increase in prices would go straight into US shale oil fields, where production would ramp up within months. Partly this reflects an inventory of drilled wells that aren’t producing (or fracked) and could be brought on line quickly, adding as much as 500 tb/d in a few months. That is hardly enough to offset something like an oil workers’ union strike in Venezuela but would contribute to the perception that prices were too high and would need to come down.

The other major factor is the potential for a large-scale inventory destocking, which would be on the same track as the traders’ perception that prices were rising too much. Traders, and possibly governments, thinking that any price increase was likely to be short-lived would take advantage of the selling opportunity putting pressure on the physical price.

The only things likely to change the range of prices would be serious changes in the fundamentals. A strong demand recovery, which should occur when the global economy rebounds, would suggest to many that a higher price is sustainable. Alternatively, if US shale oil production resumes growth to a serious degree, a lower price would be almost certain.


11 Comments on "Michael Lynch: Is $50 Oil The New $100?"

  1. rockman on Sat, 24th Oct 2015 9:07 am 

    And was $100 oil the new $35 oil of 10 or so years ago? And was that $35 oil at that time the new $17 oil of the late 90’s? And was that $17 oil the new $30 oil of the early 90’s? And was that $30 oil the new $12 oil of 1986? And was that $12 oil the new $35 oil of the early 80’s? And was that $35 oil the new $115 oil of the late 70’s? And was that $115 oil the new $20 oil of the early 70’s?

    I assume the point is under stood. LOL.

  2. Spec on Sat, 24th Oct 2015 10:58 am 

    If Michael Lynch is saying we will stay low then it is probably about to start climbing up. 😉

    I think it will climb a bit eventually after things ‘clear’. There are still a lot of fracked wells producing strongly. But as their output drops, prices may start creeping up. Then again, Iranian oil hitting the market could lower things. And who knows what Russia is going to do in the mid-east. I wouldn’t be surprised if their involvement there is just to stir the pot and raise fear in order to boost oil prices.

    Round and round and round she goes, where she stops nobody knows.

  3. rockman on Sat, 24th Oct 2015 11:18 am 

    spec – Exactly. As they say a wise man knows things. And a very wise man realizes what he doesn’t know.

  4. Plantagenet on Sat, 24th Oct 2015 1:04 pm 

    The sanctions on Iran will be lifted sometime in the next couple of months. This will allow Iranian oil to be traded on the open market and will increase supply. This is likely to make the oil glut worse and drive oil prices down further.


  5. BobInget on Sat, 24th Oct 2015 2:01 pm 

    WTI closes the year over $140. Brent $155.

  6. apneaman on Sat, 24th Oct 2015 2:18 pm 

    Why not $1?, Why not $2? Why not $3? Why not 4$? Why not $5?……………………..Why not $15? Why not $21? Why not $32? Why not $? What if it goes up for a bit then comes back down then goes up just a little bit more, then stays there, but then takes two steps sideways, stands on one foot for 3 days, does 2 back flips, hops up and down for 444 minutes, performs a series of clumsy cartwheels then takes a shit on your head and jerks off twice in 3 minutes. What then?

  7. Davy on Sat, 24th Oct 2015 2:55 pm 

    That’s fine Bob. I will call you with your $140 goes to $20 in 120 days. “You got to know when hold em, know when to fold em, and know when to shut up”

  8. tita on Sun, 25th Oct 2015 7:54 am 

    “Operating costs in oil fields are typically a fraction of the total”
    True… That’s how stripper wells work. Even in the case of a bankruptcy, the well won’t stop producing, it goes in the hands of another.
    But in the shale plays (for what I understood), production doesn’t last long if there is no money injected in the total. A shale well timelife is so short that the total costs looks more like operating costs, not just an investment for years of production.

  9. shortonoil on Sun, 25th Oct 2015 8:16 am 

    It is interesting that Lynch, and his ilk have never figured out that it is the value of the energy delivered by petroleum that ultimately sets its price. Obviously, they have no idea why petroleum is even used. They apparently feel that it is some form of existential exercise in filling up barrels. Common sense should inform them that oil that delivered no energy, that is powered zero economic activity other than its own production, would have zero value. Conversely a “supper” barrel, one that could drive an entire city for a year, would be immensity valuable.

    “The reality is that prices could do all of the above, depending on geopolitical developments more than anything else.”

    This is a wonderful conclusion that states that any problems that arise are simply the result of human activities. Depletion, climate change, over population can be resolved by maintaining the correct geopolitical balance. Lynch is convinced that humans are the Masters of the Universe. Apparently we have no physical boundaries. By accepting the correct political stance humanity will be endowed with oil at the “right” price for eternity.

    Sorry Mr. Lynch, that is the very same self servicing, self centered egotism that got into the present situation to begin with!

  10. Bob Inhead on Sun, 25th Oct 2015 9:23 am 

    What is with Venezuela? They are in real trouble because their oil is the dirtiest in the world and very difficult to process. A cut off would be a total disaster for them because all the refiners can run other heavy oil and the is a surplus. The real truth the US refiners who take 60% of their oil would be happy to go elsewhere. The hit would be mostly with their socialist buddies around Latin America who get cheap oil from them. That will b e the real impact.

  11. Kenz300 on Mon, 26th Oct 2015 9:25 am 

    The sooner the world moves away from FOSSIL FUELS the better……

    Wind and solar are the future….fossil fuels are the past…………
    Climate Change is real….. we need to deal with the cause (fossil fuels)

    Listen Up: Pope Calls for the Replacement of Fossil Fuels, Renewable Energy and Solar Subsidies – Renewable Energy World

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