The reason oil could drop as low as $20 per barrel

The reason oil could drop as low as $20 per barrel

By Anatole Kaletsky
December 19, 2014
  • An oil pump jack pumps oil in a field near Calgary

How low can it go — and how long will it last? The 50 percent slump in oil prices raises both those questions and while nobody can confidently answer the first question (I will try to in a moment), the second is pretty easy.

Low oil prices will last long enough for one of two events to happen. The first possibility, the one most traders and analysts seem to expect, is that Saudi Arabia will re-establish OPEC’s monopoly power once it achieves the true geopolitical or economic objectives that spurred it to trigger the slump. The second possibility, one I wrote about two weeks ago, is that the global oil market will move toward normal competitive conditions in which prices are set by the marginal production costs, rather than Saudi or OPEC monopoly power. This may seem like a far-fetched scenario, but it is more or less how the oil market worked for two decades from 1986 to 2004.

Whichever outcome finally puts a floor under prices, we can be confident that the process will take a long time to unfold. It is inconceivable that just a few months of falling prices will be enough time for the Saudis to either break the Iranian-Russian axis or reverse the growth of shale oil production in the United States. It is equally inconceivable that the oil market could quickly transition from OPEC domination to a normal competitive one. The many bullish oil investors who still expect prices to rebound quickly to their pre-slump trading range are likely to be disappointed. The best that oil bulls can hope for is that a new, and substantially lower, trading range may be established as the multi-year battles over Middle East dominance and oil-market share play out.

The key question is whether the present price of around $55 will prove closer to the floor or the ceiling of this new range. The history of inflation-adjusted oil prices, deflated by the U.S. Consumer Price Index, offers some intriguing hints. The 40 years since OPEC first flexed its muscles in 1974 can be divided into three distinct periods. From 1974 to 1985, West Texas Intermediate, the U.S. benchmark, fluctuated between $48 and $120 in today’s money. From 1986 to 2004, the price ranged from $21 to $48 (apart from two brief aberrations during the 1998 Russian crisis and the 1991 war in Iraq). And from 2005 until this year, oil has again traded in its 1974 to 1985 range of roughly $50 to $120, apart from two very brief spikes in the 2008-09 financial crisis.

What makes these three periods significant is that the trading range of the past 10 years was very similar to the 1974-85 first decade of OPEC domination, but the 19 years from 1986 to 2004 represented a totally different regime. It seems plausible that the difference between these two regimes can be explained by the breakdown of OPEC power in 1985 and the shift from monopolistic to competitive pricing for the next 20 years, followed by the restoration of monopoly pricing in 2005 as OPEC took advantage of surging Chinese demand.

In view of this history, the demarcation line between the monopolistic and competitive regimes at a little below $50 a barrel seems a reasonable estimate of where one boundary of the new long-term trading range might end up. But will $50 be a floor or a ceiling for the oil price in the years ahead?

There are several reasons to expect a new trading range as low as $20 to $50, as in the period from 1986 to 2004. Technological and environmental pressures are reducing long-term oil demand and threatening to turn much of the high-cost oil outside the Middle East into a “stranded asset” similar to the earth’s vast unwanted coal reserves. Additional pressures for low oil prices in the long term include the possible lifting of sanctions on Iran and Russia and the ending of civil wars in Iraq and Libya, which between them would release additional oil reserves bigger than Saudi Arabia’s on to the world markets.

The U.S. shale revolution is perhaps the strongest argument for a return to competitive pricing instead of the OPEC-dominated monopoly regimes of 1974-85 and 2005-14. Although shale oil is relatively costly, production can be turned on and off much more easily – and cheaply – than from conventional oilfields. This means that shale prospectors should now be the “swing producers” in global oil markets instead of the Saudis. In a truly competitive market, the Saudis and other low-cost producers would always be pumping at maximum output, while shale shuts off when demand is weak and ramps up when demand is strong. This competitive logic suggests that marginal costs of U.S. shale oil, generally estimated at $40 to $50, should in the future be a ceiling for global oil prices, not a floor.

On the other hand, there are also good arguments for OPEC-monopoly pricing of $50 to $120 to be re-established once markets test the bottom of this range. OPEC members have a strong interest in preventing a return to competitive pricing and could learn to function again as an effective cartel. Although price-fixing becomes more difficult as U.S. producers increase market share, OPEC could try to impose pricing “discipline” if it can knock out many U.S. shale producers next year. The macro-economic impact of low oil prices on global growth could help this effort by boosting economic activity and energy demand.

So which of these arguments will prove right: The bearish case for a $20 to $50 trading-range based on competitive market pricing? Or the bullish one for $50 to $120 based on resumed OPEC dominance?

Ask me again once the price of oil has fallen to $50 – and stayed there for a year or so.

CNN report: $1.99 gas now in 13 states and will likely become common in 2015

 dollar ninety nine gas

Gas for less than $2 is now widespread

December 15, 2014: 7:48 AM ET

NEW YORK (CNNMoney)

It was a good weekend for drivers to fill up. Cheap gas spread across the nation faster than holiday cheer.

After a weekend of price cutting at stations, gas for less than $2 can be found in 13 states across the country. Two weeks ago there was only one gas station in the country selling gas that cheap.

Data from price tracker GasBuddy.com shows that three states — Oklahoma, Louisiana and Ohio — have at least one station each selling regular gas for less than $1.90 a gallon. Cheap gas is most frequently found at stations in Oklahoma, which was the first state to break the $2 a gallon mark on Dec. 3.

Another ten states — Alabama, Arizona, Colorado, Indiana, Mississippi, Missouri, Nebraska, New Mexico, Texas and Virginia — also have gas for less than $2.

Related: What’s gas cost in your state?

Gas below $2 a gallon can only be found at a handful of stations in all these states, even in Oklahoma. Four of the states only have one station each with gas that cheap. All these states still have statewide averages well above $2 according to AAA. Missouri has the lowest average price at $2.25.

And with the statewide average in New York finally falling below $3 over the weekend, every state in the lower 48 now has an average below that benchmark. The nationwide average is now $2.55 a gallon, the lowest it has been since October 2009.

Falling gas prices have been driven by plunging oil prices. Crude traded below $60 a barrel for the first time in five years last Thursday and was just over $58 a barrel early Monday.

Falling oil prices are ‘so dramatic’

Falling demand for oil due to economic slowdowns in Europe and Asia, as well as more fuel efficient vehicles, are major reasons for the fall in oil prices. But increased U.S. oil production, which took the nation past Saudi Arabia as the world’s largest source of crude earlier this summer, is another major factor, as is a strong dollar.

With OPEC so far unwilling to cut production in order to prop up prices, some forecast that oil could fall to near $40 a barrel at some point in 2015. That would drive gas prices down even more and make gas for under $2 a gallon common at stations across the country.

Falling Oil Prices are Destroying OPEC

Revolutionary changes sweeping the world’s energy industry will drive down the price of liquefied natural gas (LNG), creating a “multi-year” glut and a much cheaper source of gas for Europe.

Francisco Blanch, the bank’s commodity chief, said Opec is “effectively dissolved” after it failed to stabilize prices at its last meeting. “The consequences are profound and long-lasting,“ he said.

The free market will now set the global cost of oil, leading to a new era of wild price swings and disorderly trading that benefits only the Mid-East petro-states with deepest pockets such as Saudi Arabia. If so, the weaker peripheral members such as Venezuela and Nigeria are being thrown to the wolves.

The bank said in its year-end report that at least 15pc of US shale producers are losing money at current prices, and more than half will be under water if US crude falls below $55. The high-cost producers in the Permian basin will be the first to “feel the pain” and may soon have to cut back on production.

Bank of America said the current slump will choke off shale projects in Argentina and Mexico, and will force retrenchment in Canadian oil sands and some of Russia’s remote fields. The major oil companies will have to cut back on projects with a break-even cost below $80 for Brent crude.

It will take six months or so to whittle away the 1m barrels a day of excess oil on the market – with US crude falling to $50 – given that supply and demand are both “inelastic” in the short-run. That will create the beginnings of the next shortage. “We expect a pretty sharp rebound to the high $80s or even $90 in the second half of next year,” said Sabine Schels, the bank’s energy expert.

Mrs Schels said the global market for (LNG) will “change drastically” in 2015, going into a “bear market” lasting years as a surge of supply from Australia compounds the global effects of the US gas saga.

If the forecast is correct, the LNG flood could have powerful political effects, giving Europe a source of mass supply that can undercut pipeline gas from Russia. The EU already has enough LNG terminals to cover most of its gas needs. It has not been able to use this asset as a geostrategic bargaining chip with the Kremlin because LGN itself has been in scarce supply, mostly diverted to Japan and Korea. Much of Europe may not need Russian gas at all within a couple of years.

Bank of America said the oil price crash is worth $1 trillion of stimulus for the global economy, equal to a $730bn “tax cut” in 2015. Yet the effects are complex, with winners and losers. The benefits diminish the further it falls. Academic studies suggest that oil crashes can ultimately turn negative if they trigger systemic financial crises in commodity states.

Barnaby Martin, the bank’s European credit chief, said world asset markets may face a stress test as the US Federal Reserve starts to tighten afters year of largesse. “Our biggest worry is the end of the liquidity cycle. The Fed is done and it is preparing to raise rates. The reach for yield that we have seen since 2009 is going into reverse”, he said.

Mr Martin flagged warnings by William Dudley, the head of the New York Fed, that the US authorities had tightened too gently in 2004 and might do better to adopt the strategy of 1994 when they raised rates fast and hard, sending tremors through global bond markets.

Bank of America said quantitative easing in Europe and Japan will cover just 35pc of the global stimulus lost as the Fed pulls back, creating a treacherous hiatus for markets. It warned that the full effect of Fed tapering had yet to be felt. From now on the markets cannot expect to be rescued every time there is a squall. “The threshold for the Fed to return to QE will be high. This is why we believe we are entering a phase in which bad news will be bad news and volatility will likely rise,” it said.

What is clear is that the world has become addicted to central bank stimulus. Bank of America said 56pc of global GDP is currently supported by zero interest rates, and so are 83pc of the free-floating equities on global bourses. Half of all government bonds in the world yield less that 1pc. Roughly 1.4bn people are experiencing negative rates in one form or another.

These are astonishing figures, evidence of a 1930s-style depression, albeit one that is still contained. Nobody knows what will happen as the Fed tries to break out of the stimulus trap, including Fed officials themselves.

Biggest transfer of wealth in history coming soon?

gas-price

As oil prices plunge, wide-ranging effects for consumers and the global economy

By Steven Mufson December 1 at 9:26 PM

Tumbling oil prices are draining hundreds of billions of dollars from the coffers of oil-rich exporters and oil companies and injecting a much-needed boost for ailing economies in Europe and Japan — and for American consumers at the start of the peak shopping season.

The result could be one of the biggest transfers of wealth in history, potentially reshaping everything from talks over Iran’s nuclear program to the Federal Reserve’s policies to further rejuvenate the U.S. economy.

The price of oil has declined about 40 percent since its peak in mid-June and plunged last week after the Organization of the Petroleum Exporting Countries voted to continue to pump at the same rate. That continued a trend driven by a weak global economy and expanding U.S. domestic energy supplies.

The question facing investors, companies and policymakers is how low oil prices will go — and for how long. Every day, American motorists are saving $630 million on gasoline compared with what they paid at June prices, and they would get a $230 billion windfall if prices were to stay this low for a year. The vast majority of that will flow into the economy, with lower-income households living on tight budgets likely to use money not otherwise spent on gas to buy groceries, clothing and other staples.

On Monday, the average U.S. price for a gallon of regular-grade gasoline was $2.77, according to AAA, which projects that prices could drop by an additional 10 to 20 cents.
(The Washington Post)
Big American companies are better off, too. Every penny the price of jet fuel declines means savings of $40 million for Delta Air Lines, the company’s chief executive said in a recent CBS interview.

“Despite the impressive recent gains in natural gas and crude oil production, the U.S. still is a net importer of energy,” William C. Dudley, president of the Federal Reserve Bank of New York, said Monday at Bernard Baruch College. “As a result, falling energy prices are beneficial for our economy and should be a strong spur to consumer spending.”
Although falling oil prices lower inflation, the Federal Reserve tends to view that as a fleeting effect that would not alter its underlying judgments about policy. Nonetheless, Dudley said, “the slump in oil prices may also help to persuade” the European and Japanese central banks to implement further monetary easing as prices remain subdued.

The consequences of the decline in oil prices are also evident in politics and pocketbooks.

At current prices, the annual revenue of OPEC members would shrink by $590 billion, money that will instead stay within the borders of the world’s biggest oil importers, led by the United States, China and Japan.

The size of the global economy will “easily be between 0.5 percent and 1.0 percent higher as a result of the decline in oil prices,” wrote Andrew Kenningham, senior global economist for London-based Capital Economics.

The 40 percent drop in the price of the international benchmark Brent-grade crude oil over the past five months will reduce annual revenue to oil producers worldwide by a whopping $1.5 trillion.

“Those losses are staggering,” Edward Yardeni, president of Yardeni Research, wrote to investors Monday.

The losers include Russia, where the value of the ruble has been crumbling, inflation has crept up to more than an 8 percent rate and oil prices have done more to hurt the economy than Western sanctions.

In Iran, whose economy and government budget rely heavily on oil sales, low prices could intensify the effect of sanctions that have curbed the country’s oil exports in an effort to pressure the regime into reaching a diplomatic accord on its nuclear program.