Thu | Dec 8, 2016

Oil is on a wild ride: How will it end?

Published:Friday | February 13, 2015 | 12:00 AM

The price of oil is on a wild ride, and there is little agreement on where it's headed.

After falling nearly 60 per cent from a peak last June, the price of oil has now bounced back 19 per cent since late January, closing Monday near US$53. Oil has fallen or risen by three per cent or more in either direction on 14 of 26 trading days so far this year. By comparison, the stock market hasn't had a move that big in more than three years.

Predicting prices is especially tricky now because the oil market has never quite looked like this. Oil price collapses of the past were triggered either by plummeting demand or an increase in supplies. This latest one had both.

Production in the United States and elsewhere has been rising, while slower economic growth in China and weak economies in Europe and Japan means demand for oil isn't growing as much as expected.

As recent trading shows, any sign of reduced production inspires traders to buy oil, and every new sign of rising supplies sends prices lower. Price forecasts for the next year range from US$20 a barrel to US$75.

"There are many more laps to come on this roller coaster," said Judith Dwarkin, chief economist at ITG Investment Research.

As oil bounces up and down, so will the price of gasolene, diesel and other fuels. Almost no one expects a return to the very high prices of the last four years, so drivers and shippers will continue to pay lower prices. It's a question of how much less, and for how long.

OIL WILL RISE

Those expecting a quick and lasting price jump see mounting evidence that drillers in the US are pulling back fast because they're no longer making money. A closely watched survey by the oil services company Baker Hughes shows that the number of rigs actively drilling for oil fell to 1,140 last week, down 29 per cent from a record high of 1,609 in October.

Oil companies have announced spending cuts in the billions of dollars; oil service companies have announced layoffs of thousands of workers.

If companies stop drilling new wells in North Dakota and Texas, the centres of the US oil boom, overall US production could fall fast. Output from most of those wells declines far more quickly than production from more traditional wells. Analysts at Bernstein Research estimate that US production declines at 30 per cent a year without constant investment in new wells.

A quick decline in production would send prices higher by reducing global supplies. At the same time, demand could be on the rise. The US economy seems to be improving rapidly and demand for gasolene is increasing. Global demand may also rise somewhat, simply because low prices tend to encourage more consumption.

If the oil bulls are right, it means prices for transportation fuels would rise and the slowdown in drilling activity in the US would perhaps be short-lived.

OIL WILL FALL

Others say oil production is still rising and demand isn't yet catching up - a recipe for lower oil prices.

The oil bears argue that there are plenty of rigs still working, and they are now focused only on the most prolific spots. Also, oil services companies are charging significantly less for equipment and expertise. This means oil companies may be able to keep oil supplies rising from already high levels despite low prices.

The Energy Department reported last week that there was a record 1.18 billion barrels of oil in storage in the US. ITG's Dwarkin estimates that in the first half of this year the world will be producing, on average, two million barrels per day more than it will be consuming.

Analysts at Bank of America Merrill Lynch say US$32 a barrel is possible. Ed Morse, an analyst at Citi, called the recent rise in prices a "head fake" and predicts oil could plunge into the US$20 range, the lowest since 2002.

The bears also don't expect much increase in demand. Many developing nations are cutting back on fuel subsidies, which means that consumers could be buying less fuel, not more. And demand in the US and other developed nations won't rise much, they argue, because of environmental policies and high fuel taxes.

OIL WILL HOLD FIRM

After its recent rise, some think oil may already be close to finding its level.

The International Energy Agency (IEA) said in a report Tuesday that prices will stabilise in a range "higher than recent lows but substantially below the highs of the last three years".

In the past, once production went off line it took years to bring it back. Now, the IEA said, drillers can quickly and easily tap shale deposits to bring new oil to market as soon as supplies fall or demand rises. That should help keep a lid on prices.

Tom Pugh, an analyst at Capital Economics, forecasts that Brent crude, the most important benchmark for global crude, will end the year around US$60 a barrel, within US$2 of where it closed Monday - and to be at US$70 by the end of 2020.

That doesn't mean, however, that there won't be further bumps along the way. "We wouldn't be surprised to see more large price movements before the market settles down," Pugh wrote.

- AP