Why $50 Oil Won’t Last

By Robert Rapier on Jan 22, 2015

http://www.energytrendsinsider.com/2015/01/22/why-50-oil-wont-last/#more-17460

In the past few weeks I have received numerous questions about the role of a “drop in demand” in the oil price decline. These questions are driven by many stories in the media that have referenced a drop in demand.

There are two primary reasons given for this so-called demand drop. One is that years of high oil prices have resulted in reductions in consumption through conservation and improvements in vehicle fleet efficiency. The second reason is due to the strengthening dollar, oil has become more expensive for many countries since oil is generally traded in dollars.

There are elements of truth behind both reasons. There has indeed been reduced oil consumption in recent years in most developed regions of the world. It is also true that the dollar has strengthened against many currencies. But despite the rationale that explains this drop in oil consumption, ultimately the data must support the narrative.

We have to keep in mind that the developed regions of the world aren’t the entire world. Despite this oft-repeated mantra about falling oil demand, there is no evidence that this is actually true. Last October, the International Energy Agency (IEA) reduced its forecast for 2014 global oil demand growth by 200,000 barrels per day (bpd). Their revised forecast was that global oil demand would only increase by 700,000 bpd from 2013.

Last week on CNBC the IEA forecast that “global growth in the demand for oil could modestly accelerate in 2015 to 910,000 barrels a day.” However, the article also noted that the World Bank had reduced their forecast for growth in the global economy for this year to 3%, down from their previous forecast of 3.4%.

What has happened is that these reductions in the forecast for oil demand growth or economic growth get mistranslated into forecasts of declining demand. I think we can all agree that if I gained 5 pounds a year each year for the past 5 years, but this year I only project that I will gain 3 pounds — I did not lose weight. I will be 3 pounds heavier than I was instead of 5 pounds heavier.

Consider that in the 5-year period of 2008-2013, the price of West Texas Intermediate (WTI) crude averaged $88/bbl. The price of Brent crude was even higher at $95/bbl over this period. These prices were much higher than the average oil price over the previous 5-year period, therefore we might expect that this had a negative impact on oil demand. This was in fact the case in the U.S. and E.U., but global demand increased, driven by increases in every developing region of the world:

Despite much higher oil prices, global demand for oil increased by more than 5 million bpd in the past 5 years. In fact, global oil consumption has increased in 18 of the past 20 years.

Now, compare that with where most of the world’s oil production growth took place during that time period:

This is why I maintain that oil below $50/bbl is simply not sustainable. If global demand was actually declining, it would be a different story. But with demand continuing to grow, and with the majority of the oil production added in the past 5 years coming from the shale oil fields in the U.S., there is simply not enough $50/bbl oil to meet demand. Consider the graphic from a Bloomberg story late last year that shows almost every shale play in the U.S. losing money at current oil prices:

Now consider that companies in these shale plays are reducing their 2015 budgets, and layoffs are underway. The cure for low oil prices is low oil prices, and that cure will begin to take effect this year. I realize that we dropped into the $30′s in 2008, but keep 2 things in mind. Just over a year later we were back above $100/bbl, and at that time the marginal barrel was not $70/bbl shale oil.

The cost to produce that last million barrels per day of demand is significantly higher than it was in 2008. Therefore oil will not — as I have seen more and more pundits predict — sink to $40/bbl and stay there. There may be a new norm for oil relative to what we have seen in the past 5 years, but it will be closer to $70/bbl than it will be to $40/bbl.

I think he's right.

In an earlier post he made his 2015 predictions (he hit 5 of 5 for 2014..)

http://www.energytrendsinsider.com/2015/01/08/my-2015-energy-predictions/#more-17422

For 2015 Rapier.. says this. 

1. The closing price of West Texas Intermediate (WTI) crude will not fall below $40/bbl in 2015.

The price of West Texas Intermediate (WTI) crude was in free fall during the second half of 2014, and it isn’t clear that the drop is over. WTI closed the year at $53.27/bbl, but due to a strong first half of the year the average for the year was $88.80/bbl. As I write this, WTI has dipped briefly into the $40’s. Barring a major international development that rocks the crude oil markets, crude oil prices aren’t going to begin to recover until probably the 2nd half of the year. I think it’s a no-brainer that crude oil prices will average less in 2015 than in 2014, but the average relative to the year-end price is a much more difficult question.

Nevertheless, I believe we are close to bottoming out. It is true that in 2008 WTI did drop into the $30’s, and a number of pundits (and some technical indicators) have suggested this will happen again. But this isn’t 2008. Most of the production that has been added around the world since 2008 has been shale oil. Much of that isn’t economic at current prices, and we will see production respond to that. I believe this will put the brakes on the decline soon, and that oil prices will bottom out above $40/bbl.

Of all the predictions I am making, this is the one with the greatest potential for being proven wrong the quickest. We aren’t all the far from $40/bbl today, and we could get there with 3 or 4 down sessions in a row. But if oil does drop below $40/bbl, it won’t be there long.

and.. 

2. The closing price of West Texas Intermediate (WTI) crude prices will average above $60/bbl.

If we look at the current futures curves, every month in 2015 currently has WTI priced ~$56/bbl, plus or minus $3/bbl. However, I believe the market has overshot to the downside, and that market fundamentals based on the production cost of the shale oil added over the past 5 years supports oil at around a $70/bbl floor. It may not happen in 2015, but I do think we will see $70/bbl as a reasonable floor price over the next 1-2 years. When oil prices do begin to recover, probably in the 2nd half of 2015, speculators will begin to pile back in and we will likely see prices overshoot to the high side.

 I can see oil trading back up to the $70-$80/bbl range in 2015, and I believe that most of the year will be spent above $60/bbl (but it may be summer before we get back to that level).

hmmm..  slowly.. turning the corner.. probably got some more back and fill to go but by summer driving season... ???