PMC Weekly Review - December 11, 2015

A Macro View – Is this a Crude joke?

In the August 21st, 2015 edition of this PMC Weekly Market Review, we discussed the causes and effects of oil’s price decline over the last eighteen months. The causes were five-fold: three were supply related, whereas two were demand related. Supply and demand factors continued to be out of balance over the last few months, leading West Texas Intermediate (WTI) Crude Oil to trade down to a seven-year low of $36.52 on Tuesday. This represents a roughly 40% decline since June 2014, and investors now are questioning whether oil prices finally have reached a bottom, or if they will continue to fall.

In short, a few investors believe that supply is either overestimated, or that supply will be cut back and cause oil price appreciation. In regards to the former, Tom Kloza, co-founder and global head of energy analysis at the Oil Price Information Service, believes the current oil supply is not as bad as it would seem. He states "This is a glut in terms of the most crude oil we've ever had in North America. But if you measure it versus the population, it's not altogether that much. We've had much more crude-per-population back in previous decades.” In regards to the latter, Alain Bokobza, head of global asset allocation at Societe Generale, told CNBC that OPEC is likely to be forced to cut production next year, as low oil prices are hurting oil producing economies. Economists at the Royal Bank of Canada (RBC) stated that there will be a “pullback in supply as the sharp drop in the number of active rigs results in lower levels of global output.” Additionally, Chevron CEO John Watson noted that the corporation plans to cut capital spending, which will cause a decline in production, and, consequently, supply. Longer term, IHS Vice Chairman Dan Yergin said last Friday that the oil market "can't stay low like this because you're not going to have the investment you need… By 2020, the world oil market is going to need another seven million barrels a day of production.”

On the other hand, a large number of investors believe oil prices will continue to fall. Allianz Chief Economic Adviser Mohamed El-Erian believes the oil market is "completely unhinged.” Conversely, Credit Suisse's co-head of global oil and gas research David Hewitt stated the last oil market cycle bottom “was a demand-(driven) world economic crisis; this is a supply issue.” Fitch Ratings, Inc. stated that “OPEC's decision last week to roll over its current policy of allowing members to essentially pump as much as they can has only put more pressure on oil prices.” In fact, it is estimated that 500,000 to 2 million barrels of crude oil are being produced in excess of demand every day. Fatih Birol, the executive director of the International Energy Agency (IEA), believes that supply could increase even more if Iran returns to production, which would further exacerbate downward price pressure.

Despite disagreement on the future direction of oil prices, experts agree that supply and demand are not in equilibrium in the oil market. Supply appears to be the larger driver of the most recent decline, and future upward movement of oil prices likely will be largely dependent upon future changes in said supply. Although future movement is uncertain, we all can agree that low oil prices are cutting billions from countries’ budgets and threatening the oil and gas industry in America. Prices being held down by the continued glut of supply are nothing to joke about.

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