The price of oil is volatile. It’s like the GEICO commercial says “everybody knows that.” Texans in Houston know it. Texans in Midland and Odessa know it.
The oil companies know it, too. Some of their stock prices are off 40 percent in just a few months. Stockholders don’t like 40 percent losses. It doesn’t take a CEO long to begin postponing projects, laying off or furloughing workers and cutting costs everywhere.
Some experts have tried to estimate just how low the price would need to fall before new exploration shut down. The fact of the matter is that some companies have much lower production costs than others. Some companies have hedged their 2015 production. This means that somebody has agreed to buy all the oil they can produce for $95 to $100 a barrel, regardless of how low the market price falls.
How low can it fall? Nobody knows. This big drop in price has caught everyone off guard. Look at the chronology of comments from key players in the oil market.
- October 3: Price drops below $90 after Saudis announce a price cut.
- October 13: Kuwait oil minister says “natural floor for prices at $76 to $77.”
- October 15: Price drops to $81.84.
- October 15: Saudi prince says Saudi Arabia needs $80 to $90 to balance the budget.
- October 28: Goldman cuts price target for oil for 2015 from $90 to $75 for West Texas Intermediate crude (WTI).
- October 28: Citigroup expects Brent crude to be $92 in first quarter 2015.
- October 28: Deutsche Bank predicts Brent will be $88.
- November 4: Saudi price cut moves WTI to $77.
- November 7: OPEC officials say “at $70 there will be panic in OPEC” and “were prices to fall below $70, there will be action from OPEC.” However, OPEC doesn’t expect price to fall below $75 in the near term.
- November 13: Brent fell below $80 for the first time in four years.
- November 13: The Energy Information Agency (EIA) forecasts WTI to average $77.75 in 2015, down from its previous $94.58 estimate.
- December 4: Saudis say oil could stabilize at around $60, a price they believe they could withstand.
- December 9: Morgan Stanley sees Brent average of $70 in 2015.
- December 12: “Prices set to drop toward $50.”
- January 6: WTI trades at $48.
As you can see from this sequence, even the smartest people in the industry were caught completely off guard. As late as October 28, Goldman Sachs thought oil would be $95 this year. As late as November 13, the EIA thought oil would be $77.75 in 2015.
OPEC countries signaled they would like oil to be $80, and that there is a natural price floor around $77, and that prices below $70 would cause a panic.
Oil is a commodity, like gold and silver. Commodity prices can fluctuate dramatically in a very short period. Speculators have a strong influence in commodity markets. This is why prices can spike upward in a violent fashion and collapse with astounding quickness.
Take a look at the price of oil in the chart below. Notice how oil collapsed from above $140 to $32 by December 2008. The world economy was imploding and the United States was in a credit/banking crisis.
Notice also how fast the price of oil recovered, even in the most difficult of times. In just 12 months, the price of oil had recovered to $79 by the end of 2009.
My opinion is that the price of oil will bottom out this spring as speculators drive the price to the absolute bottom (whatever that may be). Marginal production in the United States will shut down first, because investor funding for new wells will dry up. As U.S. production slows, the price of oil will stabilize.
OPEC countries and Russia will suffer heavy damage with prices at these lowest levels. Internal social pressures will build to the point that these governments finally agree to cut production. This announcement will signal the bottom of the oil price decline debacle.
When will this happen? It will happen when the pain of low prices gets so intense that OPEC calls a special meeting and “adjusts” its production schedule.
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