Falling oil prices: Why the oil bust is here to stay

Falling oil prices are just one part of a broader commodity super cycle that appears to be ending, but the oil bust has captured the attention of the world in ways crashing coal and copper prices have not. And, for now, it looks like falling oil prices are here to stay.

LM Otero/AP/File
A well pump works at sunset on a farm near Sweetwater, Texas. Falling oil prices have caught producers across the globe off-guard.

The oil industry has experienced boom and busts before, but the depths to which oil prices have plunged have surprised everyone. Could the bust now persist much longer than many think?

It is not just oil that has seen a bust. Over the last decade and a half, the global economy has witnessed a massive commodity boom, with prices rising for all sorts of raw materials, including gold, iron ore, oil, gas, copper, wheat, corn, and more. But the commodity “super-cycle” appears to be over, with vast new supplies having come online in the last few years.

As prices rose through the 2000’s, multinational companies extracting all sorts of commodities planned billion dollar projects. With new mines, new oil and gas fields, and other commodity supplies hitting the market at the same time, a bust has ensued. (Related: Gains From Low Oil Prices Could Be Wiped Out This Year)

“Supply has been outstripping demand not because demand has been particularly weak, but because there was too much supply,” Stephen Briggs, a commodities analyst at BNP Paribas SA, told The Wall Street Journal. “It looks like this won’t change anytime soon.”

The oil bust has captured worldwide attention in a way that crashing coal and copper prices have not. And for now, the bust may here to stay, at least a bit longer than many anticipated.

For example, Goldman Sachs sharply downgraded its assessment for crude oil prices. The investment bank now says that it sees Brent trading at around $42 per barrel over the next few months, down from its previous forecast of $80 per barrel. It also says that WTI will fall to $41, a downward revision of its previous $70-per-barrel prediction.

Many market watchers have predicted a “floor” in prices at each key threshold – $70 per barrel, then $60, then $50. But crude prices have ignored these forecasts, plunging to fresh lows each week over the past few months. Just last week, major hedge fund manager Andrew J. Hall said $40 would be an “absolute price floor,” another threshold that is within striking distance.

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Saudi Prince Alwaleed bin Talal threw cold water on the markets even further with his recent comments.

“If supply stays where it is, and demand remains weak, you better believe it is gonna go down more. But if some supply is taken off the market, and there's some growth in demand, prices may go up. But I'm sure we're never going to see $100 anymore,” he said in an interview with USA Today. 

There are several reasons low prices may persist. First, production is still at elevated levels. OPEC is holding strong to its production levels, despite unease among many of its members. And U.S. shale companies are maintaining output for the time being. That will likely change later this year as hedges expire and companies are forced out of the market, but in the short-term, the U.S. probably won’t see a decline in production.

Also, there is excess storage capacity that is allowing producers to continue to pump. Some companies are even storing oil on unused tankers at sea, betting that they can sell the volumes later at higher prices.

Finally, as oil prices fall, so do the costs of production. The cost of materials, along with the rates drillers pay to rent out rigs, deflate with the price of oil. That makes breakeven cost projections a bit of a moving target. (Related: Canada: A Microcosm Of The Ultimate Effect Of Low Oil Prices?)

“To keep all capital sidelined and curtail investment in shale until the market has rebalanced, we believe prices need to stay lower for longer,” Goldman Sachs wrote in their latest report.

Speculators don’t know what to make of the oil markets right now. Some are pouring money into bets on prices rising, while others are wagering that prices have further room to fall.

We will learn more about the state of the U.S. oil and gas industry over the next few weeks as fourth quarter earnings are released. For the energy sector as a whole, profits are expected to fall by 19.1 percent. Some companies will be in worse shape than others, which could give us an indication of where production levels are heading, and with them, how long oil prices will stay low.

By Nick Cunningham of Oilprice.com

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Source: http://oilprice.com/Energy/Energy-General/Could-The-Oil-Bust-Last.html

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