Over the last forty years, the crude oil market has endured a topsy-turvy ride. From the days of the Yom Kippur War of 1973 when crude prices spiked to $70 a barrel, to the lean days of the early 1980s when crude oil fell to $10 a barrel, and moving forward to the boom of the first Gulf War, with subsequent price drops all the way to $9 a barrel in 1998, and down to modern times when the price of crude oil has moved from two-digit to three-digit and back to two-digit figures, it has really been a roller coaster ride.
After going above $140 a barrel at the height of the Libyan Civil War of 2011, the price of crude oil has dropped systematically ever since by more than 60%. As at Wednesday August 19, 2015, the price of crude oil fell to 6-year lows of just about $40 a barrel. Many industry watchers and indeed the global population are asking: what next?
An understanding of the complex interplay of factors affecting the crude oil market as well as a historical look at trends in the market, will paint a picture as to what the future holds in this market for market players. Crude oil has always had its peaks and troughs, with various factors responsible for the swings in prices. Some of these factors have remained relevant, other factors have paled in significance and new fundamentals have emerged.
There was a time when the member countries of the Organization of Petroleum Exporting Countries (OPEC) were the kings of the market. Whenever they sneezed, the world caught a cold. Things began to change when the first barrels of crude oil were discovered and drilled from the North Sea, bringing countries like Norway and Russia into focus as dominant world players in the market. The discovery of the second largest crude oil reserves in the world in Canada’s oil sands added to the mix. But perhaps, the greatest changes to the crude oil market were triggered by the Gulf War of 1991, which led to record prices at the time and also led to Iraq being kicked off the global market for several years. At the same time, China began to emerge as a global production powerhouse, guzzling millions of barrels of crude oil to feed its thirsty industries. Global demand soared, prices shot up and oil producing nations were awash with cash. Unfortunately, some of the countries that benefitted from the oil windfall of the early and mid 90s put the money to nefarious use. Leaders like Muammar Ghaddafi simply found more money to sponsor terror groups and rebel insurrections in Liberia and Sierra Leone. Iran and Qatar began to assert regional influence by surreptitiously funding groups like Hamas and Hezbollah, which were classified as terror groups by the United States.
The Global Financial crisis of 2008 led to a drop in demand as cash-starved economies began to scale back on spending, causing crude prices to fall to as low as $39 per barrel in 2009. The drop in prices was short-lived. Within two years, the Arab Spring kicked off in Tunisia and spread across the Middle East, as citizens of oil rich countries who did not enjoy the dividends of the fat years rose up against their leaders. The Libyan civil war, which kicked off in February 2011, drove oil prices to as high as $146 per barrel. High prices were maintained when Iran was sanctioned for failing to comply with calls to scrap its uranium enrichment program.
THE BUBBLE BURSTS
For countries like the US where domestic prices at the pump are immediately adjusted to the global crude oil prices, it was time to change consumption patterns. The United States, which had for a long time borne the brunt of swings in oil prices, decided it was time to secure its supplies by stepping up local production with new technologies and cutting down its dependence on external oil supplies. This led to the development of shale oil technology which effectively ramped up production in the US to a high of 9 million barrels per day.
China, which had contributed to higher crude prices as a result of its rapid industrialization, has sort of slowed down on its consumption as the central government is now advocating for a slower and more sustainable growth pattern, cutting its GDP estimates to a modest 7% for 2015. Recent data suggest that this estimate may be too optimistic.
Increased global supplies helped by the new US shale production and the reduction in global demand caused crude prices to slump by 60% in 18 months to just under $50 a barrel. Prices retraced upwards briefly, only for a deal to be struck between the United States and Iran over the latter’s nuclear program in July 2015, paving the way for the flow of Iran’s oil into the markets once more. Crude prices have responded to this renewed increase in supply by falling to as low as $40 a barrel, hitting 6 year lows.
What makes the new price situation a bit tricky is the fact that some of the fundamental influences that have driven down prices are not transient. US shale oil production is here to stay. Iran has been given a reprieve to sell oil with the nuclear deal, which will add to global supply. China’s economy is not expanding anytime soon going by recent data. Many countries are looking at alternative energy sources with renewed zeal.
So the big question is: what is the future of oil prices in the immediate future, and how can crude oil traders and those who trade commodity currencies trade this commodity heading into 2016?
THE VARIOUS PLAYS
Traders can decide to:
- Trade crude oil itself
- Trade stocks of companies in the oil industry
Crude Oil
If we follow historical price movements of crude oil, such as price movements between 2009 and 2011, then we can say that crude oil is going to go back to between $65 and $70 a barrel. This level seems to be the sweet spot for stakeholders in the industry and many have agreed with this call. Another factor which lends credence to this call is that shale oil production is actually more expensive than conventional methods of drilling that have been in use for decades. What this means is that if prices fall too low, profit margins on oil made using shale technology will be eroded and shale producers in the US may have to halt production until prices go back up to levels at which their operations can become profitable once more.
However, there are some who believe it will get a bit worse before it starts to get better. Citigroup is predicting that crude prices will get all the way down to $32 a barrel. So we may see prices going a bit lower before they rise. A crucial factor in the equation is what Saudi Arabia will do about its production quota. At the last major OPEC meeting to decide on whether member states should cut back on production, Saudi Arabia blatantly refused to support a cut in production quotas. At US$672.1 billion, Saudi Arabia has plenty of foreign exchange reserves to cushion any shortfalls in prices, and they used this as leverage in the negotiations. They effectively outmuscled countries like Nigeria (with just $28 billion) and other members of OPEC who have foreign reserves that have dwindled massively and were hoping that the cartel would order cuts to shore up oil prices; a move which would help them to balance their budgets. So Saudi Arabia holds the trump card in OPEC. If the Saudis favour cuts in future, this would definitely shore up prices.
Oil Companies
Increased oil prices would not automatically help oil companies. We have been at an era when companies made profits with $20 per barrel, and also seen a time when crude prices were much higher but companies made less money as a result of bludgeoning costs. Going forward, companies would be forced to restructure operations, cut operation and overhead costs and probably merge to form bigger companies. Traders who are trading oil stocks would be more concerned with some of these fundamentals rather than trading simply on rise or fall of oil prices.
Disclaimer
It is important to seek the advice of your professional trade advisor before performing any trades in the market. The information in the article is for informational purposes only and should not be used as a recommendation to trade crude oil, oil stocks or any other associated assets.
