Oil drops below $30 a barrel – where next?

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2015 was a very bad year for those in the business of extracting stuff from the ground.

Commodity prices tumbled, with oil, copper and iron in free-fall.

I think oil in particular will drop even further during 2016, bottoming out at around $15 a barrel, perhaps recovering to around $25 by the year-end if we’re lucky.

And here’s why ……..

During 2016 Iran and the US will begin exporting oil, two significant events that will add to the downward pressure on price in a market where supply already exceeds demand. In fact, oil is so oversupplied globally that producers are running out of storage, there is literally nowhere left to store it, and so the only thing you can do with your oil is sell it, pushing the price down further.

At the same time, demand growth will continue to fall during 2016 due to the slowdown in developing economies, particularly Asia. China’s energy consumption growth in 2015 was its lowest since 1998, according to official news agency Xinhua. Whilst the lower price has lifted demand in some economies, global economic growth is expected to be “disappointing” in 2016 according to the IMF.

And there’s no indication that Saudi Arabia will change its policy of maintaining oil production levels to protect its market share and in the hope that the low price will eventually shut down high-cost producers, such as US shale-oil, tightening the market again.

(A forlorn hope perhaps as America’s shale-oil boom is largely based on many small companies applying new, innovative techniques. Small means flexible and the ability to quickly respond to any price fluctuation. Yes, some will go under, but their assets will be picked up debt-free by others with little break in production.)

Saudi Arabia itself isn’t immune to the effects of the crisis, announcing public spending cuts and rises in tax, fuel and energy prices for 2016. Its growing budget deficit means that just to pay the bills it may have to keep pumping flat-out and even consider selling off the jewel in its crown, Saudi Aramco.

However, it thinks it can withstand the slump for longer than US producers and seems to be preparing for a prolonged period of low prices. Saudi oil costs around $10 a barrel to produce so the price still has some way to fall to reach their tipping point.

So supply is going up, demand is going down and there’s unlikely to be any significant upward pressure on prices any time soon, a combination of circumstances leading to an especially bad situation for producers/exporters, but good news for importers, like the UK.

It’s also a great time for companies with strong balance-sheets to make acquisitions. Those that can are adapting and becoming more efficient. Lower energy costs means bigger profits across all sectors which means more taxes. Consumers have more cash in their pockets. All good news for their economies.

But there have also been job cuts, falling wages and margins, businesses are going under. I live and work in Aberdeen where the local economy is being hit hard, affecting everyone. And countries like Venezuela, Algeria & Nigeria are facing serious financial problems and political unrest with people out of work and prices rising (Scotland would also have been a candidate for this list in the coming years had the 2014 independence referendum vote gone the other way!).

So, is a world of cheap & plentiful oil going to be the new norm?

In the long-term perhaps not, just don’t expect a significant rebound any time soon.

The price will continue to fall until global demand picks up or until Saudi Arabia is forced to take action, i.e. ease back on production. Either way I predict we’ll be close to $15 a barrel by then.

On that cheery note it’s …

Bye for now.

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