If there’s one asset class that can affect the entire global marketplace, it’s oil. A notoriously fickle commodity, black gold sets the tone for economic sentiment and can single-handedly drive global markets on a day-to-day basis.
Its influence can be easily referenced by taking a look at how financial markets reacted to oil’s sudden decline in the late summer of last year. As a leading economic indicator, a drop in oil values generally means falling energy demand – a sign of an upcoming economic slowdown. Adding to the volatility in oil prices is the way supply is controlled by OPEC. Back in November of last year, oil dropped 10% in a single day, on the news that oil supply would not be cut despite the lack of demand. As a result, an oversupply issue developed and oil fell even further.
However, oil has bounced off its previous lows, and seems to be moving in an upward direction. As 2015 comes to close, investors are wondering what the forecast for oil and the global economy will be for next year.
Oil Catalysts That Could Be Triggered
Oil prices have been trading in the $40-50 range since August, with a temporary tick over $50 in early October. While it seems to be stuck in this trading range, there are a number of factors that could mean oil doubling its value in the next twelve months.
Offshore and onshore drilling companies stacked rigs during the collapse last year, trying to cut back on production expenses that are beginning to catch up to oil reserves. Because it takes time to get rigs set up and active again, there is a delay in increased production when the economy starts to move forward. As oil reserves begin to drop, oil prices will rise in value.
The US oil rig count is still dropping, with the total number now down to 757, contrasting from a year ago when it stood at more than 1,600. If demand for black gold rises in the near future, these companies may not be able to reverse course quickly enough, which could create a spike in oil prices.
In decades past, OPEC had almost complete control of global oil supply and increased or decreased supply as they saw fit. However, new players in the space, such as the US shale oil industry, have wrestled control away from the group. This made oil more sensitive to economic changes, resulting in higher volatility.
The oil cartels’ insistence on maintaining their position as the world’s supplier of oil meant that production was kept high despite a lack of demand, which exacerbated the decline in oil values for the past year. If other oil producers can take more market share, they’ll be able to curb supply more easily and create a more stable oil market.
Geopolitical risk is the number one factor affecting oil. Uncertainty and fear pushes oil higher overnight, and developing issues could mean more instability in the future. The attacks in Paris, as well as the recent shooting down of a Russian military aircraft by Turkey, have impacted oil prices and added to the volatility in the energy sector. If tensions rise or another development breaks out, oil could shoot up almost instantly.
The Bottom Line
While the future of the global economy is still uncertain, oil’s direction generally indicates what the future will bring. Drastic cutbacks in the energy sector will help reduce the current supply glut and new production from non-OPEC sources will help create a more stable market. The rise in oil values will likely be a slow one, but geopolitical concerns could cause it to spike rapidly. While increases in oil reserves can still hurt prices, there are far more positive catalysts for oil than there are negative.