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Oil Is Still Heading to $10 a Barrel


Back in February 2015, the price of West Texas Intermediate stood at about $52 per barrel, half of its 2014 peak. I argued then that a renewed decline was coming that could drive it below $20, a scenario regarded by oil bulls as unthinkable. But prices did fall further, dropping all the way to a low of $26 in February. Since then, crude rallied to spend several weeks flirting with $50 per barrel, a level not seen since last year. But it won’t last; I’m sticking to my call for prices to decline anew to $10 to $20 per barrel.

Recent gains have little to do with the fundamentals that led to the collapse in the first place. Wildfires in the oil-sands region in Canada, output cuts in Nigeria and Venezuela due to political unrest, and hopes that American hydraulic fracturing would run out of steam are the primary causes of the recent spurt.

But the world continues to be awash in crude, and American frackers have replaced the Organization of Petroleum Exporting Countries as the world’s swing producers. The once-feared oil cartel is, to my mind, pretty much finished as an effective price enforcer. Even OPEC’s leader, Saudi Arabia, is acknowledging the new reality by quashing recent attempts to freeze output, borrowing from banks and preparing to sell a stake in its Aramco oil company as it tries to find new sources of non-oil revenue.

The Saudis and their Persian Gulf allies continue to play a desperate game of chicken with other major oil producers. Cartels exist to keep prices above equilibrium, which encourages cheating as cartel members exceed their allotted output and other producers take advantage of inflated prices. So the role of the cartel leader, in this case Saudi Arabia, is to cut its own output, neutralizing the cheaters to keep prices up. But the Saudis suffered market-share losses from their previous production cuts. OPEC has effectively abandoned restraints, with total output soaring to as high as 33 million barrels per day at the end of last year:

Iran, freed of Western sanctions, plans to double output to 6 million barrels a day by 2020, which would make it the second-largest OPEC producer behind Saudi Arabia. Russia continues pumping to support its economy after the collapse in oil prices devastated government revenue and export earnings. War-torn Libya is also ramping up production as best it can.

The International Energy Agency predicts that even with a successful OPEC production freeze, if U.S. frackers cut production by 600,000 barrels a day this year and a further 200,000 barrels per day in 2017, excess supply would run at 1.5 million barrels a day until 2017. That’s a continuation of the recent oversupply of 1 to 2 million barrels a day.

The price at which major producers chicken out and slash production isn’t determined by the prices needed to balance the budgets of oil producing nations, which are as high as $208 per barrel in Libya and as low as $52 per barrel in Kuwait. Nor is it the “full cycle” or average cost of production that includes drilling costs, overheads, pipelines, etc.

In a price war, the chicken-out point is the price that equals the marginal cost of producing oil from an established well. Once fracking operations are set up and staffed, leases paid for, drilling underway and pipelines laid, the marginal cost of shale oil for efficient producers in the Permian Basin in Texas is about $10 to $20 per barrel and even lower in the Persian Gulf.

Furthermore, fracking costs continue to fall as productivity improves. The number of drilling rigs operating in the U.S. continues to drop. But the rigs taken offline are mostly old vertical drillers that drill only one hole per platform, while horizontal rigs — able to drill 20 to 30 wells per platform like the spokes of a wheel — increasingly dominate. So output per working rig is accelerating.

At the same time, global economic growth, and therefore demand for oil, is weak. China, that giant consumer of oil and other commodities, is shifting to services from manufacturing and infrastructure spending. Energy conservation measures in the West are curbing oil demand. And technological advances in fracking, horizontal drilling, deep-water and Arctic drilling will boost non-OPEC supplies to as high as 58.6 million barrels per day this year from 58.1 million in 2015.

And don’t forget the crucial influence of inventories on prices. After all, with global output exceeding demand, the extra crude goes into storage. And when the storage facilities are full, the surplus will be dumped on the market to the detriment of prices. Cushing, Oklahoma, the delivery point for determining the price of West Texas Intermediate, is nearing full storage capacity; the same is true for the Amsterdam-Rotterdam-Antwerp region, the oil gateway to Europe. China is running out of capacity for commercial and strategic reserves. Globally, crude oil inventories have jumped to record levels, with a leap of 370 million barrels since January 2014.

Surplus oil is also being stored on ships, even though so-called floating storage costs $1.13 per barrel per month compared with 40 cents in Cushing and 25 cents per month in underground salt caverns, like those used for the U.S. Strategic Petroleum Reserve. Furthermore, as low oil prices have made shipping by train unprofitable, rail tank cars are being utilized, with so-called rolling storage costing about 50 cents per barrel per month.

So what will trigger renewed price declines? Excess production will end up being dumped onto the market. Pressure from lenders on financially-weak energy borrowers will force them to produce as much oil and gas as possible to service their debts. The likely continuing rise of the safe-haven dollar against the currencies of developing economies will hype the cost of imported oil — universally priced in the U.S. currency — further curbing demand. Finally, the likely slowing of global economic growth and oil demand in reaction to the U.K. decision to leave the European Union reinforces my pessimism.

An oil price drop to below $20 per barrel would be a shock reminiscent of the dotcom collapse in the late 1990s and the subprime mortgage debacle that produced the 2008 financial crisis — both of which triggered recessions. Of course, oil prices would not stay in the $10 to $20 barrel range indefinitely; recession would squeeze out excess energy production and prices would recover, likely to the average cost of new production. But the deflation that might accompany a worldwide economic downturn might mean the new equilibrium price for oil is between $40 and $50 a barrel — well below the $82 average in the first half of this decade, and lower than the assumptions in the business plans of energy producers.


19 Comments on "Oil Is Still Heading to $10 a Barrel"

  1. dissident on Tue, 28th Jun 2016 7:42 pm 

    This clown wants people to believe that fracking costs are falling so fast that fracked oil will be just as cheap to produce as oil from Ghawar. Does he also have a bridge in Brooklyn to sell?

    And there is also supposedly a vast pool of oil just waiting to hit the market which is being stored on tankers. Aside from tin foil hat “analysis” this clown does not have any evidence that it is actually there.

    The real story all these snow jobs are diverting from the is the global recession. The recession is getting worse so demand is falling. Hence we have the mythical “glut”. But for some reason the oil price is about $48 per barrel. Why is this commodity market not conforming to the wishes of this clown? Maybe the market is responding to actual information and not rabid delusions.

  2. shortonoil on Tue, 28th Jun 2016 7:49 pm 

    “But the Saudis suffered market-share losses from their previous production cuts. “

    In the 60, some years, of Aramaco they have never failed to sell a single barrel of oil that they produced, and sell it at world market price. What this guy is talking about is anyone’s guess?

  3. lp on Tue, 28th Jun 2016 8:09 pm 

    Indonesia was added to OPEC hence the rise you need to look at OPEC with Indonesia added back to 2012.Look under OPEC production. Bloomberg is wrong

  4. Plantagenet on Tue, 28th Jun 2016 9:38 pm 

    The Saudi oil minister declared the oil glut over several weeks ago. But if we are actually still in an oil glut then the current price rise may just be a temporary spike before oil prices drop again


  5. JuanP on Tue, 28th Jun 2016 10:03 pm 

    “Recent gains have little to do with the fundamentals that led to the collapse in the first place.” That is as far as I read. Supply and demand are balancing and have been for a while. I expect further supply disruptions in the future, too. At today’s price of around $50 we can expect more investment cuts in US shale, Canadian tar sands, deep water offshore, and Arctic exploration and production.

    Anyone who thinks supply can be increased further to match demand growth is smoking the good stuff. I wish I could smoke that shit, too, but I had to quit it because for me it is either stoned all day every day or don’t touch it at all. My addictive personality and obsessive compulsive nature don’t allow me to consume drugs with moderation so I had to quit because I am too old to be a pothead. 😉

  6. MikeX11.2 on Tue, 28th Jun 2016 11:33 pm 

    shortonoil, the Saudi’s used to cut their production, to keep prices high, like Debeers and diamonds.

    But, they started losing marketshare.
    And now they undercut US prices to get that marketshare back.

    Which is all consistant with your statement that they sell every barrel of oil they put on the market.

  7. MikeX11.2 on Tue, 28th Jun 2016 11:35 pm 

    The Koch’s are still running their tar sand operation.
    They are barely making any money, they just like to be the pollution ahole kings.

  8. Northwest Resident on Wed, 29th Jun 2016 12:21 am 

    “American frackers have replaced the Organization of Petroleum Exporting Countries as the world’s swing producers.”

    It doesn’t get any funnier than that. Or more pathetic.

  9. GregT on Wed, 29th Jun 2016 12:33 am 

    “But, they started losing marketshare.
    And now they undercut US prices to get that marketshare back.”

    Makes perfect sense. Produce flat out at $100/bbl, or produce flat out at $50/bbl. Either way they sell every barrel of oil they put on the market. Who cares about the money, right?

  10. Danlxyz on Wed, 29th Jun 2016 6:40 am 

    There is a lot of truth to what he says. I’m not so sure about the ability of the LTO producers to significantly reduce costs and increase production from here on out, but time will tell.

    What he doesn’t mention is the decline rate of established fields. I have read that it is something between 2% and 6% depending on the wells and much higher for the LTO wells. 2% of 96 million is about 2 million. That will naturally take care of the excess production in a period of time.

  11. marmico on Wed, 29th Jun 2016 8:08 am 

    Anyone who thinks supply can be increased further to match demand growth is smoking the good stuff.

    Did you first discover the good stuff in 2006? What a pity.

  12. shortonoil on Wed, 29th Jun 2016 9:31 am 

    “That will naturally take care of the excess production in a period of time. “

    Probably not; as oil production declines so also does the economy that generates the demand for the oil. If there were no economy there would be no demand for oil; if there was no oil there would be no economy. The two can not just be arbitrarily separated as often happens to squeeze them into an ECON 101 model. With LTO that is pretty close to a barrel of supply to a barrel of demand. With the present oversupply of 2mb/d it would take a cut of at least 4.5 mb/d to balance the market. The impact of oil production is an energy function, not a volumetric one.

  13. frankthetank on Wed, 29th Jun 2016 4:08 pm 

    Let me know when it gets here. I’ll fill up my gas cans.

  14. Outcast_Searcher on Wed, 29th Jun 2016 4:15 pm 

    How many randomly wrong calls does A. Gary Shilling, permabear, have to make before people stop listening to him? How many false predictions of US economic depressions, major recessions, $5000 gold, etc?

    Where do his new paying customers come from? A pool of youngsters who can’t read or do web searches?

  15. Jim on Wed, 29th Jun 2016 4:35 pm 

    A different opinion, from another Bloomberg columnist, Why oil prices could hit $130:

  16. shortonoil on Wed, 29th Jun 2016 5:48 pm 

    “A different opinion, from another Bloomberg columnist, Why oil prices could hit $130: “

    Another commentator that never asks, or answers one essential question; “what is a barrel of oil worth to the economy”. In other words at what price does does it pay to invest your money in a horse? Oil is not a magical substance; it is not Pixie Dust. It does not grant infinite rewards for its use. Without that one absolutely essential number they are throwing darts in a Gin Mill at 3:00 in the morning. They have moved from analysis to wild ass speculation!

  17. JuanP on Wed, 29th Jun 2016 6:26 pm 

    Marmi, I discovered the good stuff in 1984. I quit smoking it around 2006.

  18. makati1 on Wed, 29th Jun 2016 6:54 pm 

    I don’t bother reading these oily price articles. They are like the Stock Market Casino. A camel farts and the price goes up. Another camel farts and it drops again. No reason, just the need to generate words for a paycheck.

    Not worth my time to read as I have no investment in either beyond how they affect my much simpler life. If the internet goes down tomorrow and never comes back, it will only mean I use my time differently. Not the end of the world. Ditto for the price of oil. I will adjust to it. We all will.

    And, yes, I DO understand how the death of the internet would stop all online transactions including banking, ATMs, my SS, etc. But if the internet is gone, so is cell phone service, etc. What can take out both? An EMP either nuclear or natural. Can it happen? Of course. The question is: “Are YOU prepared if it does?” Same with the price of oil. lol

  19. Danlxyz on Wed, 29th Jun 2016 7:01 pm 

    The EIA Weekly Petroleum Report says that crude oil production is down another 55,000 bod this week. The 4 week average is down from 9,600,000 bod last year to 8,690,000 bod this year. That is a drop of 9.5% over the year.

    Stocks are down a little too since Memorial Day but they always go down in the summer.

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