Oil prices: Why the free fall may be ending

Global oil supplies are strong and demand remains relatively tepid, so why would crude oil prices suddenly stop dropping around $80 per barrel? There are several built in stabilizers that could act to support crude oil prices.

Hasan Jamali/AP/File
An oil pump works at sunset in the desert oil fields of Sakhir, Bahrain. The rapid decline in crude oil prices may be almost over.

The rapid decline in oil prices may be almost over.

That prediction comes from several big banks that say oil prices are nearing their floor. Bank of America and BNP Paribas see $80 as a floor price and argue there is a high likelihood Brent oil will not crash through that key threshold.

Global supplies are strong and demand remains relatively tepid, so why would oil prices suddenly stop dropping when they reach $80 per barrel? There are several built in stabilizers that could act to support prices.

First, high cost production could begin to go offline when prices drop to that point. $80 a barrel is where some of the world’s most expensive oil starts to become unprofitable. With high cost producers knocked out of the market, supplies tighten and prices rise. (Related: World’s Most Expensive Oil Project Just Got More Costly)

However, there would be a lag effect for this, as it is likely that drillers would keep pumping at wells that are already completed, and just put off plans for new drilling projects. So production would not necessarily decline immediately, but would drop over a period of time as wells deplete and no new wells come online to replace that lost production.

A second reason for the $80 floor price is related to the global economy. With oil prices now about 30 percent lower than their peak in June 2014, fuel costs for consumers around the world are going down. That acts as an enormous stimulus. For every $20 decline in the price of a barrel of oil, U.S. GDP increases by 0.4 percent. Put another way, American drivers save around $120 per year for every 10-cent drop in the price of gallon of gasoline.

And with a jolt to consumer economies, demand could begin to come back and push up oil prices. “You have to believe there’s a cyclical rebound coming in the next three months,” Francisco Blanch, a top commodities researcher at Bank of America, said in an interview with Bloomberg. “A lot of emerging economies are going to benefit from a strong dollar, strong U.S. economy and lower energy prices. The drop in prices will be pretty stimulating for demand.”

Citigroup estimates that lower oil prices are going to pump $1.1 trillion into the global economy. That’s because consumers are not only saving at the pump, but also because lower oil prices will trickle down to affect many other consumer products.

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“A reduction in oil prices also results in a reduction in prices across commodities, starting with natural gas, but also including copper, steel, and agriculture,” Ed Morse, Citigroup’s head of commodities research, toldBloomberg. “All commodities are energy intensive to one degree or another.” (Related: 2014 May Be A Crucial Year For Iranian Oil)

But most important for the short-term swing in prices is what OPEC does next. OPEC is set to meet on Nov. 27, unless it responds to Venezuela’s plea for an emergency meeting. Saudi Arabia, the only country that really matters when it comes to changes in short-term supply, has shown a willingness to tolerate lower prices to maintain market share.

However, according to Reuters, Saudi Arabia is reportedly eyeing prices of around $80 per barrel as an acceptable level. Should prices drop well below that figure, the calculations could change in Riyadh, prompting a reevaluation of Saudi production levels. They could act in November to cut back on production in order to stop the slide. Already, one billionaire Saudi prince has written a letter to Saudi Oil Minister Ali Al-Naimi warns of a “catastrophe” if oil prices slide too far.

That means these combined forces could halt oil’s slide at around $80 per barrel. And with Brent trading around $83 on Oct. 15, we are zeroing in on that crucial price point. BNP Paribas sees oil prices rebounding to $95 per barrel by the end of the year.

By Nick Cunningham of Oilprice.com

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Source: http://oilprice.com/Energy/Oil-Prices/Is-the-Oil-Price-Slide-Nearing-an-End.html

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