Crude Oil Prices Down But Can They Recover?

Without any doubt, one of the most keenly watched assets of 2016 has been Crude Oil. Since hitting a 13-year low on February 11th, crude oil prices have rebounded from the $26.05 low by approximately 40%, but are still around 70% lower than 2014 prices. On Friday we saw the price of crude oil plummet 4% as the prospect between an agreement to freeze output between the two age old rivals Saudi Arabia and Iran, grew less likely. As the trading week begun, crude oil prices have already fallen over 1% in just the Asian trading session, with a barrel now trading at $36.37, down 1.14%.  Investors are now asking the question, how much further can crude oil prices fall? Let’s have a look at the key factors in deciding where crude oil prices will go.


US Production

The US is the world’s largest consumer of oil as well as being the world’s largest oil producer. Despite a consistently declining weekly rig count, which saw a further 10 rigs being mothballed last week alone, oil production in the US has remained stubbornly high. Approximately 9 million barrels are being produced daily in the US and despite increased costs, widespread bankruptcies and a falling rig count, the levels being produced show no signs of abating.  Even with a consistent falling rig count, the US production is expected to fall by around 772,000 barrels a day in 2016.


Supply and Demand

Since the economic crash of 2008, global economic growth has slowed and the world’s leading economies have been reducing demand for oil to fuel their industries. China, the world’s second largest consumer of oil is experiencing an unprecedented slowdown in growth, reducing demand. It is only now when crude oil prices falling to the levels they have done that manufacturing has become cheaper and the green shoots of recovery are more evident. The same also applies to the US and even the EU, with recent strong PMI readings indicating the importance of lower oil prices have had in boosting industrial output and profitability.

Whilst the demand has been falling, the supply has been increasing. Basic economics tells you that rising supply and falling demand equal lower prices. Although some improved global growth is raising demand, it is not a rate fast enough to make serious inroads into the supply levels, especially as there has been no correlating falling production to match the falling demand, This brings us nicely to the what many believe is the key factor on what will most likely happen to crude oil prices; a freeze in oil production.


Saudi Arabia and Iran

These two long-time rivals could well hold the key to the fate of crude oil prices. Since sanctions were lifted on Iran, the world’s seventh largest oil producer has added at least another 500,000 barrels daily, contributing to a market that is already oversupplied.  Saudi Arabia, the world’s second largest producer of oil, is desperate to freeze production but will only do so if Iran agrees too.  However, Tehran has been resisting all overtures for a production freeze (funding global terror doesn’t come cheap!) so far. Although Iran is expected to attend a meeting between the largest oil producers in Qatar on April 17th, it may not necessarily partake in negotiations. The Islamic Republic saying that it will not agree to any output freeze until its crude exports return to  the pre-sanction levels.

Undoubtedly, the next meeting in Qatar will play a crucial role in deciding the fate of crude oil prices. The rivalry between Iran and Saudi Arabia, already being fought in a proxy war in Yemen, will potentially scupper any oil production freeze. Although, financially not in the greatest shape, Saudi Arabia withproduction costs of around $9-10 a barrel can afford the price to stay low…just. However, nations like Canada and the US and even Russia have higher production costs than in the Gulf states, so they cannot afford to let crude oil prices fall less than $30 a barrel for any length of time.

Expect an agreement to eventually be made between Iran, Saudi Arabia and the other OPEC countries soon. As soon as the likes of Russia start applying pressure, an agreement will have to be made. Another reason why crude oil prices may rise is that the US and other economies are showing signs of recovery. The outlook in heavy oil-consuming economies like China and India is looking better and indicates increased demand.  Also, pointing to an increase in crude oil prices is the falling rig count in the US. Last week alone, there were 10 less rigs producing oil. Should this continue, and there is no reason to think otherwise, then oil production in the US will have to decline.

Overall, despite a few obstacles in the way, we can expect crude oil prices to increase in 2016. The market conditions are not for the $100 a barrel days, but if the Gulf states can come together and agree a production halt then we can expect to see crude oil prices rise well beyond the $50 a barrel mark. However, oil is a slave to geo-political influences and the instability in the Middle East is always difficult to predict and account for.

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Daniel Simmons