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By Robert Rapier on Feb 5, 2015 with 6 responses

Oil Prices: Dead Cat Bounce or Have We Passed the Bottom?

When I made my energy predictions for 2015, I made some very aggressive predictions. Perhaps the most aggressive was that the closing price of West Texas Intermediate would not fall below $40/barrel (bbl) in 2015. Why do I consider this a particularly aggressive prediction? Because on the day I made it, the price of WTI closed at $48.80, but in each of the previous three months the price of WTI had dropped at least $10/bbl over the course of the month. So if WTI had maintained the same downward trajectory, it could have easily ended January below $40/bbl. My prediction could have been proven wrong before we even got out of January, so I really stuck my neck out on that one.

It’s not that there is anything special about $40, and I acknowledge that it’s possible that we could overshoot. But I made the prediction to highlight my conviction that $40 oil simply isn’t a sustainable price in today’s world.

A number of respected pundits are projecting that we will go below $40/bbl, with some suggesting that crude could even crash all the way to $30/bbl. Last week on CNBC, respected oil analyst Stephen Schork said “I do think this is a dead cat bounce”, elaborating that at least over the next 2 to 3 months that there is too much oil supply relative to current demand. My point is that it has been a widely held belief that oil is going to fall below $40/bbl, so I am definitely on the wrong side of conventional wisdom on this prediction. That’s not a safe place to be, because when you are wrong in that case people think “Everyone read this correctly except for you.”

But I think conventional wisdom is wrong in this case. 

The thing about the oil and gas markets is that traders are typically looking further down the road. It is widely expected that the supply/demand balance will tighter up in the 2nd half of 2015, so I reasoned that traders would start to position themselves well before that time. I explained the underlying basis of my prediction in that initial article, and then elaborated in the article preceding this one — Why $50 Oil Won’t Last. In a nutshell, I don’t believe the situation in 2008 — when oil prices fell into the $30s — applies today for two reasons. First, global demand is 5 million barrels per day higher than it was in 2008. Second, most of the new oil production added in the past five years came from the shale oil fields in the U.S. Most of that production has breakeven costs above $40/bbl, which is a higher break-even than the marginal oil production from five years ago.

Nevertheless, I knew that at the rate crude prices were falling, there was a very real risk that we could overshoot to the downside. I just reasoned that traders would start to bid prices back up on the anticipation that market conditions would be better for crude oil in a few months. And a funny thing happened in January. The decline in the price of WTI was much slower than it had been during the previous five months. For the first time since September, the monthly change in the price of WTI was less than $10/bbl:

Chart A

But there is more to the story than that if you look at the rate of change over the past year. Oil prices trended slightly up during the first half of 2014, began to fall in the second half of June after peaking above $107/bbl and continued to decline throughout November. Following OPEC’s Nov. 27 decision not to cut production quotas the decline accelerated. That decline didn’t slow down until mid-January, when prices broke from the downward trend and flattened out:

Chart B

So, instead of ending January below $40/bbl, WTI finished the month at $48.24, up over 7% from the previous day’s close. This increase was despite the fact that earlier in the week the Energy Information Administration (EIA) reported that U.S. crude oil stocks rose by almost 9 million barrels over the past week to reach nearly 407 million barrels, the highest level since the government began keeping records in 1982. As I write this, the price has broken back above $50/bbl — a 17% increase in just the past week.

One thing I have noticed over the years is that when oil prices are plummeting, traders tend to ignore bullish news, and when they are climbing bearish news is often shrugged off. While oil could resume its decline this month and disprove my prediction by the end of February, the fact that the price of WTI rose despite news that should have sent it lower may indicate that we have passed the bottom. If we don’t break below $40/bbl by the end of March, I think it’s highly unlikely that it will happen for the rest of the year.

Link to Original Article: Oil Prices: Dead Cat Bounce or Have We Passed the Bottom?

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

  1. By Forrest on February 6, 2015 at 7:28 am

    Stock’s advanced per the news of increased oil prices. I know the success of U.S. oil companies is good for stocks, I get that. But, what must be said, the event is not so good for the consuming public at large. Our politics often refer to wealth created at the top and attempt wrong headed populist emotional solutions, i.e. tax the rich. The wealth is created by policies of government, not as much by evil high earners. Cheap money propels the wealthy. High regulation conformance cost usually favors large corporations and most of all international corps. Illegal immigration favors investors, not wage growth or job creation. The huge cost of gaining favor upon Capitol Hill favors deep pocket business of international corps. This is classic Big Government operations. So, one can understand low cost of oil will put money in pockets of citizens, but the money will be blown per ability to pay credit cards and avoid usury fees of corp wealth generation. The wealth will be spent upon upon small business pizza, dinning, movies, and repair shops. Great news for the folks whom represent the vast majority of public, but not so good for corp wealth creation and stock market force.

  2. By Ben on February 7, 2015 at 9:59 am

    Let’s face it, few macroeconomic factors really account for the 60% correction in the price of oil of recent months. Indeed, an argument might be made that the performance of the US economy over that past few quarters would typically support healthy demand and, correspondingly, prices. It may be more of a testament to emotionalism than supply and demand factors that account for today’s prices, just as it could be similarly argued that a suspension of underlying facts influenced the long overdue reduction of oil prices for the past few years.

    RR is sensible in his analysis where he consistently cites the underlying factors that ultimately move markets. The bottom-line costs of producing the next barrel of oil remains the relevant benchmark. While I may challenge how those costs are (mis)represented by some in the industry, it’s fair to suggest that the operative number in nearly all markets is significantly higher than today’s prices. Such underlying costs are an unavoidable discipline imposed on the marketplace. Even a collapse in global energy demand, which very few are forecasting, will not alter the economic requirements associated with energy exploration, development, production and transport. It is this inconvenient truth of production costs that holds sway on market pricing and no measure of wishful thinking, or geopolitical machinations, will change the way the world works.

    Significantly higher prices (than today’s) are the new normal and momentary relief is little more than a timely, de facto tax break for the US and world economy. It is an acknowledgment of the temporary nature of such relief that has the Federal Reserve holding the line on quantitative easing here at home while the European central bank advances its own QE efforts. In the coming months, the convergence of higher energy costs and the absence of further stimulus (consumer demand and equity asset appreciation) from financial repression will begin to works its way through the global economy. The underlying economic assumptions of growth upon which our federal budget, and those of all other national economies, squarely rest will confront a new round of challenges that will greatly complicate our efforts to safeguard liberty and security at home and abroad.

    We might do well to avoid the petty distractions of politics in the build up to the next round of elections. Alas, the media remains fixated on the constant side-show in Washington.

    Ben G

  3. By Russ Finley on February 7, 2015 at 3:54 pm
    • By Robert Rapier on February 7, 2015 at 4:26 pm

      Incredible combo of mismanagement and the government of Brazil (majority owner of Petrobras) forcing the company to subsidize fuel purchases for Brazilian citizens.

      • By Russ Finley on February 7, 2015 at 4:38 pm

        …the government of Brazil (majority owner of Petrobras) forcing the company to subsidize fuel purchases for Brazilian citizens.

        Translation: Politicians raiding the public larder to buy votes …sounds familiar.

  4. By Forrest on February 14, 2015 at 8:09 am

    As you know oil prices reflect economic health and ability to pay more for the enjoyment of the resource. There is much brewing about that could devastate international economy. Quantitative Easing is just a fancy and backhanded trick to print money that has gained much acceptance per policies of hurting economies. Politicians will always jeopardize the future per easy solutions as they can’t sell the public upon correct medicine. This is the history of economic collapse. The U.S. has maintained health of economy per our recent oil wealth, not per brilliance of central bankers tricks. However, it appears other ailing economies would just as well put faith in such Voodoo economics per politician’s flim flam and gain acceptance of pop culture public ed trained voting public. Hopefully, the process won’t blow up on their watch and they can gain historical significance per rolling the dice brilliance. But, another budding problem that has most economist concern is the ISIS warriors disturbance of Middle East. If this group can’t be quickly decimated and squashed the fear is growing popularity of the movement. Since this region is the Eden of oil production the economic ramifications of failed state operation and black market production would be traumatic to global economy. This is the biggest fear to date and not Putin’s skunk tricks. We have many economic bubbles floating about with weak economies attempting to print their way out of harms way. Our CIC seems aloof to it all, attempting to settle concerns with phony advertising and have it both ways without doing much of anything. Political mastery to accomplish little and blame others. That’s the stuff of greatness.

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