Which direction for Oil prices ?

An article by Christopher Dembik, global head of macroeconomic research at Saxo Bank, and published on Tout sur l’Algerie's July 16^th, 2016, in partnership with La Tribune covers oil prices issues by asking Which direction for Oil prices? .

"For the first time in two years, the downward spiral on oil price appears to have stopped.  The price of a barrel of oil has stabilized around the $50 mark, which corresponds to the target of OPEC for end of 2016.  Difficulties in production in several countries, particularly in Libya, Nigeria and Venezuela, as well as the rise of the summer demand in the United States helped to reduce the little excess supply in the market.  However, it may not be yet the end of the downward trend.

Four main arguments are feared to bring the price of a barrel of oil down in the coming months.

First, the price war continues between Saudi Arabia and Iran in order to regain market share.  Compared to June 2014, monthly production of Saudi Arabia increased by 4.2% while that of the Iran increased by 13%.  Despite official speeches, there's no appeasement on oil production between the two countries.  After proposing a barrel at dumped price to the Asian market, Saudi Arabia has last week turned to the European market.

In the short term, the market is focused on Iran and Saudi Arabia, but in the longer term, it is the increase of Iraqi production that poses the greatest risk on the supply.  Compared to June 2014, the country’s production experienced the highest increase among the producers, about 32%.  In the years ahead, the increase in production is likely to escalate despite the still persistent geopolitical risks in the Mesopotamian Crescent.

Shale gas’ return ?

Second, OPEC cannot afford oil to permanently establish itself above the threshold of $55 - $60.  From this level, U.S. oil shale operators are again profitable and will be able to flood the market with their production within few weeks.  In just two years, impressive technical progress has been made for some wells in South Dakota to be profitable even around $20 - $25 per barrel.  OPEC is perfectly aware that it will not be able to win the war against shale gas whose development is inexorable.  However, it will try to delay the return of U.S. operators on the market so as to enable its member countries to reduce their dependence.  Therefore, under no circumstances there may be a price of a barrel of oil at $60 in the coming quarters.

Third, there is historically, a negative correlation between the Dollar and the oil price.  When the U.S. Dollar appreciates on the foreign exchange market, it results in a downward pressure on the price of a barrel of oil.  The process of normalization of monetary policy by the US Central Bank should accentuate the rise of the Dollar.  Investors have already, incorporated this perspective in the price up to May, the Dollar recorded its biggest monthly increase for two years in relation to ten main counterparts.  The exchange rate of the US currency increased by 3.7%.  In a world where rates of return are marginal almost everywhere, only the US economy is an attractive investment opportunity. Therefore, the request for $ increases which strengthens the exchange rate of the greenback and penalizes the price of a barrel of oil.

A bearish supercycle

Fourth, since the industrial revolution in the 19^th century,  raw materials evolved according to supercycles lasting on average between 30 and 50 years.  The world economy is at the fourth supercycle.  Oil, like gold and copper, is no exception to the rule.  From 2008-2011, all raw materials have involved in a bearish supercycle that could last at least until 2022-2025 depending on models.

These past months have shown that forecasting accurately the price of a barrel of oil is an impossible exercise.  On the other hand, it is not risky to say that the price of a barrel of oil should remain low in the coming years.  In fact, it is a return to normal.  From 1861 to today, the average real price of a barrel of oil was $33.90.

The anomaly is not the current period, but the 2011-2014 when the price of a barrel of oil was around $100."

Translation from French by Microsoft / FaroL  faro@farolco.onmicrosoft.com