Oil prices extended losses on Tuesday on worries about the global glut of oil. U.S. crude has fallen 60% from its $107 high in June 2014 to just under $44 a barrel. The question now is what’s next?
We suggest that the next move may still be lower. Here are 7 reasons why.
There’s a lot of oil out there. U.S. energy weekly production is at an almost 32-year high at 9.4 million barrels per day, according to the Energy Information Administration. And when supply exceeds demand, that’s like to push prices lower.
There’s no stopping oil producers. The glut of supply will likely continue. Not only is U.S production at a multi-decade high, it is also growing double digits from a year earlier. In the week ending March 6, production was at 9.4 million barrels a day versus 8.1 during the same week a year ago. That’s a 14.5% jump from a year earlier. This pace will likely continue into 2016, as U.S. oil production will eclipse 9.6 million barrels a day, according to the EIA. This would result in the highest U.S. production since 1970, or more than 45 years.
Global growth is muted (at best). As U.S. oil production grows, there isn’t much demand to absorb the glut of oil supply. Oil consumption is closely correlated to economic growth. Globally, economic growth is faltering – it is slowing in China, negative in Japan, flattish in Europe, and likely to slow in the United States this year. What’s more, the outlook for global demand for oil suggests that it will hit a 12-year low in 2017 — more than 600,000 barrels less than OPEC forecast a year ago for 2017 demand. The International Energy Agency has also dropped its oil outlook consistently over the last year — specifically, four times. It now sees a surplus of approximately 400,000 barrels in 2015.
Saudi Arabia can sustain lower prices. In theory, the world’s largest oil producer needs $90 a barrel oil to fund its budget, but has more than $726 billion in foreign reserves it can use to fund its budget during periods of sustained lower prices.
Oil fields are more resilient than you think. A survey of 2,222 oil fields globally found that only 1.6% would have negative cash flow at $40 per barrel, according to a recent report by Wood Mackenzie.
Oil dependent nations have no choice but to produce. In major oil producing and dependent countries like Russia, the government may have no choice but to produce at lower prices. Roughly 42% of Russian government spending are financed by oil exports. In other words, to cut production in an environment where prices have collapsed would be economic suicide for the Russian government.
It’s getting tougher to find a spot to store all this oil. It is expected that Cushing and other U.S. repositories will be completely full by the May/June 2015 timeframe. In aggregate, U.S. storage is at an 80-year high of 448.9 million barrels, which is up 23% from a year ago. A similar trend is playing out globally. OECD commercial inventories totaled 2,741 million barrels at the end of 2014, which was the highest level on record and equivalent to roughly 58 days of consumption. The EIA projects these inventories to rise in 2015. What’s more, OPEC surplus crude oil production capacity, which is concentrated in Saudi Arabia, is expected to increase to an annual average of 2.3 million barrels a day bbl/d in 2015 and 2.7 million barrels a day in 2016, after averaging about 2 million barrels a day in 2014, according to the EIA.
Daryl Jones is the Director of Research and Ben Ryan is a commodities analyst at Hedgeye Risk Management.
