Will the price of oil resume its downward plunge?

by omouggos

There is glut of oil on the world markets. (image from finance.yahoo.com)

Around the middle of February crude oil, as measured by the West Texas Intermediate (WTI) exchange, reached a low price of ~$26.00 per barrel. Since then the price of oil has steadily risen, notwithstanding a recent pull-back that has been reversed, to almost $42 per barrel.

One may wonder what is fueling this rise in oil prices. Of course the bullish will say that oil has bottomed and a recovery in commodity prices are under way. It appears that bullish hope has been kindled in the oil market thanks to the talk of an oil production freeze by the major producers Russian and Saudi Arabia. In fact, we are told, that during the upcoming Doha meeting between Russia and OPEC nations that this production freeze will be formally agreed upon.[1]

However, regardless of the recent price action in oil and the belief that a oil production freeze will be agreed upon, there are many indications that the price of oil will resume its downward plunge. While contemporary markets are rigged, manipulated and highly distorted, we should always remember that fundamentally the price of any commodity or thing is dictated by its supply and by the demand for it.

With this in mind, there appears to be a glut of oil currently being produced. Zerohedge has reported that multiple countries are currently producing record amounts of oil.[2] Russia at 10.9 million barrels per day (mbd) and Iraq at 4.55 mdb. Furthermore countries like Kuwait and the UAE plan on increasing their oil output. Iran has just announced that they are now exporting 2 mbd of oil, compared to only 1 mdb during the sanctions.[3] They also hope to raise oil exports to 4 mdb by March 2017.[4]

In a sense the world is awash in oil, so much so that there is a massive maritime “traffic jam” of oil tankers, housing 200 million barrels of oil.[5] As such even with a production freeze, there is still a glut of oil on the world market, which if economic reality prevails, should cause a lowering in oil prices.

Yet it is unlikely that there will in fact be an oil production freeze. As mentioned Iran intends to up their oil exports and have rejected Saudi Arabia’s oil freeze plan.[6] The Saudis have responded that they will only freeze production if “all countries agree to freeze production.”[7] As such it seems very unlikely that the hoped for and expected agreement will materialize in Doha. It should also be noted that Saudi officials have stated that they are able to withstand low oil prices “for a long long time.[8]

While it is evident there is a lot of oil supply in the world today, the other part of the equation is demand. Regardless if there is record quantities of oil being produced, if there is a high level of demand consuming that oil, then we are not in a state of oversupply and the price of oil can easily increase. However, it does not appear that demand for oil is overly strong.

It should be remembered that modern economies are based on fossils fuels such as oil, and if the global economy is doing poorly then demand for oil will be low. It is apparent that the Chinese economy is doing poorly,[9] at least by its own high standards of prior double digit growth, and at worst it could actually be contracting. While in America, the Atlanta Federal Reserve estimates that 2016 Q1 GDP growth will only be 0.1%.[10] As such there is plenty of evidence indicating that future oil demand will not keep pace with the glut of supply.

It is becoming increasing apparent based on the fundamentals of supply and demand that the price of oil will likely decrease, possibly considerably, some time in the near future. Sooner or later the irrationality that is currently governing economic markets, will be overwhelmed by reality. But when that time will come is anybodies guess.

Now there is one viable reason to be bullish on oil and that is geopolitical uncertainty. For some odd reason, much of the world’s oil is found in regions that are prone to geopolitical instability, i.e the Middle East. Already there are reports that oil fields are being closed in Libya due to the military operations of ISIL in that area.[11] If ISIL were to somehow launch a successful attack on Saudi Arabia’s oil fields or their refineries, or if a wide scale war broke out between Saudi Arabia and Iran, then the price of oil would skyrocket.

So I guess when one accounts for supply and demand, rigged markets, geopolitical instability, and the irrationality of many market participants, then the safest conclusion pertaining to oil prices is to expect volatility and lots of it.

O Mouggos

References

[1] http://www.cnbc.com/2016/04/11/oil-prices-dip-but-hold-above-40-ahead-of-producer-meeting.html

[2] http://www.zerohedge.com/news/2016-04-10/iraq-latest-announce-record-oil-production-why-just-beginning-supply-glut

[3] http://www.presstv.ir/Detail/2016/04/03/458898/Iran-oil-exports-sanctions-Saudi-freeze/

[4] http://www.presstv.ir/Detail/2016/04/06/459396/Iran-oil-output-/

[5] http://finance.yahoo.com/news/band-plays-global-oil-glut-130103301.html

[6] http://www.zerohedge.com/news/2016-04-03/iran-oil-minister-rejects-saudi-demand-freeze-crude-production

[7] http://www.zerohedge.com/news/2016-04-03/iran-oil-minister-rejects-saudi-demand-freeze-crude-production

[8] http://money.cnn.com/2016/01/21/investing/davos-energy-saudi-oil/

[9] http://davidstockmanscontracorner.com/chinas-monumental-ponzi-heres-how-it-unravels/

[10] http://www.zerohedge.com/news/2016-04-08/atlanta-fed-slashes-q1-gdp-estimate-only-01

[11] http://www.presstv.ir/Detail/2016/04/12/460316/Libya-oilfields-shutdown-Daesh/

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