EnergyInsights.net 
The only certain thing about oil's price is its uncertainty 30-05-2016 3:57 pm
oil 
What next for oil prices? Credit: Alamy
 

A large number of clever people backed by deep-pocketed employers spend a great deal of time trying to work out where the oil price is heading. It’s rather surprising, therefore, how wrong most of their predictions are.  Forecasts generally amount to extrapolating the recent past.

When the oil price hit $150 a barrel in 2008, many thought that it would reach $200; earlier this year when the price of Brent crude hit $26, experts (often the same ones who were warning of the price spike eight years ago) predicted further falls to $15.

In both cases, the pundits were left looking foolish as the oil price headed in the opposite direction. Last week a barrel of oil cost $50 again for the first time in seven months. The oil price has doubled since January, confounding the bears and raising the question of just how far the rally can go from here.

There are several reasons why the price of crude has surged in recent weeks, most of them easy to understand but hard to predict. First, fears that the market would continue to suffer from chronic oversupply have been allayed by output disruptions in a number of key producing countries.

Militants in Nigeria have shut down production amounting to 800,000 barrels a day, a 40pc reduction on the recent peak level. Wildfires in Canada have knocked that country’s output by around a million barrels a day. War has taken its toll in Libya. The implosion of its economy is wreaking havoc in Venezuela.

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Oppositors of Venezuela's President Nicolas Maduro set up fire barricades during demonstrations
Oppositors of Venezuela's President Nicolas Maduro set up fire barricades during demonstrations Credit: AFP/Getty

Stockpiles in the US fell by more than 4m barrels last week, much more than expected. Meanwhile, the other side of the equation is also putting upward pressure on the price. Demand is rising in the world’s biggest oil consumer as the American driving season gets under way against a positive backdrop of economic recovery and an improving jobs market.

For an extended period we waited in vain for American consumers to spend the windfall of cheap energy; belatedly, they are now doing so. Consumption is rising in the world’s big emerging markets too. Chinese oil imports are up 12pc this year. Consumption in India has risen 10pc as car sales there hit a new record.

The doubling in the cost of Brent in recent months is a sign that the world is finally healing after the financial crisis

Expectations of a rebalancing of the global oil market in the second half of 2016 looked optimistic a few weeks ago; today, they look sensible. The implications of a resurgent oil price are significant and wide-ranging because many other markets are highly correlated with energy’s ups and downs.

In particular, equity markets have marched in lock step with oil this year (somewhat counter-intuitively when you consider that cheap oil is in some ways akin to a tax cut for consumers). The reason for this close link is the way in which the oil price has come to be seen as a barometer of the health of the global economy.

The doubling in the cost of Brent in recent months is a sign that the world is finally healing after the financial crisis. It is no coincidence that the stalled equity rally has picked up again in the last few days as oil has broken through $50. Rising oil means a nascent rise in US inflation (already higher than in other developed markets) can start to take hold.

Storm clouds gather over Shell's Pulau Bukom oil refinery in Singapore
Storm clouds gather over Shell's Pulau Bukom oil refinery in Singapore Credit: Reuters

That in turn means the odds of the Fed hiking rates again in June or July are materially shorter than just a few weeks ago. So how far can oil go? The lazy approach of extrapolating into the future argues for further gains from here.

The recent slashing of exploration budgets by cash-strapped oil majors like Shell supports that call. I think it would be foolish to expect much more of the same, however, because the oil market is remarkably self-regulating. The best cure for a low oil price is precisely that low price.

Dwindling returns make marginal production unviable and it quickly stops. We have seen that in the shale fields of North America which are pockmarked by wells that have been drilled and capped.

But the same process also works in reverse. As oil rises above $50 a barrel, these mothballed sites will be re-activated. At $60 a barrel, new drilling will begin again. The US is the oil world’s new swing producer and shale is much quicker to switch on and off than conventional production.

In the Middle East, too, the proxy war between Saudi Arabia and Iran means the taps are likely to be kept wide open. Riyadh isn’t going to give its regional rival a free pass by shutting down production while Tehran ramps up output into a rising price.

I expect the oil price to move broadly sideways from here in a new range between $40 and $60. But I offer that prediction with some trepidation. The past few years have shown that forecasting the oil price is a mug’s game.

www.telegraph.co.uk/

 

 

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