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:
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:
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?