Oil has been the headline for almost two years now and there’s still no sign of normalcy coming any time soon. The price of oil keeps sinking thanks to a refusal by OPEC to cut production and low global energy demands, prompting many to wonder what exactly oil will do next.
The fight OPEC has been putting up in an effort to kill U.S. shale oil has kept energy prices at historically low levels for an extended period of time. Adding to the complication is the fact that the global economy appears to be running out of steam. The collapse of the Chinese stock market alerted investors to a larger underlying weakness that has continued to plague financial markets. Without some clear evidence of where the economy is headed, attempting to predict what oil will do next will be fraught with complications and errors.
The Oil Industry Is Still Trying to Reinvent Itself
Rumors have been circulating over the past month about a possible production cut or freeze coordinated between Russia and Saudi Arabia, but so far nothing concrete has come out of it. The addition of Iran’s oil output is only pouring more into oil reserves, keeping oil from rising off its lows.
In order to absorb the oversupply, U.S. oil companies have taken drastic measures in order to stay solvent and productive. Oil rig closures have been one of the primary ways these companies have tried to stave off losses. Last Friday, a report revealed another drop in U.S. oil rig numbers, marking the 10th straight week of closures. Total rigs in operation now number just 400 – the lowest figure since December of 2009.
According to data gathered by the Bureau of Economic Analysis, the rig count has fallen at a 94% annualized pace over the past several weeks. Counting oil and gas rigs, the total is now just 502 in the U.S. That number is down from 619 at the end of January and 700 from the end of December. In the latter half of 2014, the total oil rig count was over 1,600, revealing just how far the oil industry has gone to stave off losses.
The International Energy Agency (IEA) estimates that the production of U.S. oil from shale or fracking will fall by several hundred thousand barrels over the next several years due to a lack of investment in the energy sector. The agency had stated previously that oil markets could stabilize in late 2015 but has since revised that estimate to 2017.
The Bottom Line
Even if oil production in other countries is cut and oil begins to rise, it wouldn’t make much of a difference. If oil hits the $40 mark, that could prompt Saudi Arabia to start ramping up production again which would flood the oil market yet again and cause prices to crash. It’s a vicious cycle that would repeat over and over again unless there’s some other fundamental economic change.
For the time being, we can expect oil to trade in the mid-$30 range for at least the next couple of quarters. If the economy begins to pick up again, as many analysts expect will happen later this year, oil could finally breach the $40 mark and stay there. Still, the industry is going through so much change that trying to accurately pinpoint oil’s fair value has become more of a guessing game than anything else.