Sunday, January 04, 2015

Things To Consider About Oil Prices In 2015

Let's be frank here, I did not think oil prices would plummet like it did. It is largely a black swan event which went past the estimates of a large majority of investors, experts and amateurs. So this is not anything profound, its just some important pointers that one should know going forward.

$50-60 for oil seems like soo... drastic, and it is for all players within the oil and gas arena. More so for economies that are highly dependent on oil revenue for a substantive part of their budget spending.

A look at the chart below show the budgeted price of oil for their "revenue estimates", blue was the price budgeted for 2014 and red is for 2015, both were WAY OFF ... something's got to give ...
a) A real correction or an aberration - The thing is on hindsight ... this 
correction is not an aberration but the last 5 years for oil prices to be around $100, now that was an aberration. The long term, 20-year average is, in today's money (adjusting for inflation), is more like $US60. It wasn't that long ago that the Organisation of the Petroleum Exporting Countries was targeting $US25 oil, which back then seemed a comparatively high price. 

b) The new normal, or the real normal - On hindsight again, the price upswing of oil coincided with two major developments. It started from $40 to above $100 over the last 5 years owing to China's so called unstable demand, China's unstoppable growth projections, and China's storage of oil to ward of excessive oil price increase; plus the easing of money supply from most developed nations affected by the subprime and Euro crisis. Hence if we are shifting to the new normal - the new normal has China struggling to post moderate growth, the new normal has seen China being over invested in many mines (commodities), the new normal is seeing a mismatch between demand and supply, the new normal has seen shale/fracking oil being a major contributor to the supply equation.

c) Supply brought on by high oil prices - Turn back the clock to 200 and price of oil is less than $30. The rise and rise of oil prices have caused large investments and spending in innovation and research, which brought forth much of the new supply. Its like a pendulum, you swing extreme on one side then you swing back to rebalance. In much the same vein as any new "innovation/ventures", e.g. the rise of internet, smartphones, online shopping, etc... every time there is a new "area", the investing community will throw money at it to speed up extraction of easy money till its no longer easy like now. These dishes of liquidity is deemed as necessary as it pools funds into innovation and new ideas, but will throw off excesses as well.

d) Contango looking bright - If someone were to examine future delivery for oil, the futures' prices is much higher thus leading many to conclude that a strong rebound is imminent. I believe this has more to do with remnants from players still fixated with oil prices at $80-$100. There is a strong inherent bias in the way we make estimates or guesstimates or even make prediction - its called "anchor & adjust", which in itself is usually useful but would preclude us or blinkered us in terms of our decision options. An example is that if we have seen oil trading at $80 for the past 2 years, if we were to hazard a guess for the price of oil 6 months down the road, we would anchor at $80 and adjust slightly up or down depending on our beliefs and knowledge of the subject matter, henceforth in that case most guesstimates would probably be around $70-$90. It would take gargantuan balls and chutzpah to call for oil prices to be at $60 or $110 6 months down the road.

Above was the daily production back in 2001 by countries. Just look at the current daily figures. Most economies' budget have probably increased multiple folds from 2001 to2014. Russia's pumping more today than in 2001 and is in a more severe position financially. While we have been fixated by shale oil from the USA, its not the culprit in the supply equation - the USA has been constant in its daily production back in 2001 and today. What has changed is the emergence of Canada (oil sands) and China, they were nowhere back in 2001.

CountryProduction (bbl/day)Share of
World %
Date of
 World84,951,200100%2014 est.[6]
1 Russia10,053,80013.80%2013 est.
2 Saudi Arabia9,693,20013.09%2013 est.
3 United States7,441,20012.23%2013 est.[7]
4 China4,372,0005.15%2014 est.
5 Canada3,856,0004.54%2014 est.
6 Iran3,518,0004.14%2014 est.
7 Iraq3,400,0003.75%2013 est.
8 United Arab Emirates3,087,0003.32%2013 est.
9 Venezuela3,023,0003.56%2013 est.
10 Mexico2,934,0003.56%2013 est.
11 Kuwait2,682,0002.96%2013 est.
12 Brazil2,633,0003.05%2013 est.
13 Nigeria2,525,0002.62%2013 est.
14 Norway1,998,0002.79%2013 est.
15 Algeria1,885,0002.52%2013 est.
16 Angola1,840,0002.31%2013 est.
17 Kazakhstan1,635,0001.83%2013 est.
18 Qatar1,631,0001.44%2013 est.
19 United Kingdom1,099,0001.78%2011 est.
20 Colombia1,011,9920.97%2013 est.
21 Azerbaijan987,0001.20%2011 est.
22 Indonesia982,9001.66%
23 India897,3001.04%2013 est.
25 Oman890,5000.95%2013 est.
26 Argentina796,3000.93%2013 est.
27 Libya700,0000.85%2013 est.[8]
28 Egypt680,5000.80%2013 est.
29 Malaysia693,7000.82%2013 est.
30 Ecuador485,7000.58%2013 est.

Hence in the current scenario, we have a loaded situation wherein most player have seen oil prices dropping 40% over the past 3 months. Thus at $60, most futures would see a strong bias on the upside as many believe they may have missed out on the big drop already. The chances, seemingly, is higher for it to go higher than lower from $60 in the next 3 to 6 months.

That is a huge fallacy in my view. Thats because if you think that, you are basing it largely on how oil has been trading for the past 4 years. However, as explained, this correction is taking out the excesses of easy money and depleted demand in light of rising output. In my view oil has a higher propensity to go to $40 than $70 over the next 3-6 months. I wish I will be wrong, I really do.

1 comment:

OwYang said...

black swam event, just like the flood.

well, life goes on. the question is, will it be worst than 1997? or better?