The price of oil is charging lower once again. At time of writing, Brent crude is trading at $55.06 per barrel, $6.30 above its five-year low of $47.80/bbl printed at the beginning of this year.
Unfortunately, if the past few weeks are anything to go by, the price of Brent could push to a new five-year low in the next few weeks. Many analysts are predicting just that.
Supply/demand story
This week the World Bank downgraded its forecasts for global oil consumption over the next two years. At the same time, Saudi Arabia announced that its production had hit record levels, despite the fact that prices are in freefall.
Meanwhile, production of oil in the United States remain at 40-year highs. Even though oil prices are falling, shale producers continue to drill more wells, adding to the region’s oil glut. On top of these factors, new supply from Iran could be about to hit the market. It’s estimated that Iran could add an additional 1m barrels of oil per day in supply to the oil market.
So all in all, it’s pretty clear that the oil market is oversupplied, and until supply begins to fall or demand rises dramatically, the price of oil will remain depressed.
Heading lower
City analysts believe that the price of oil could head lower by more than 20% from present levels, which would take it below $45/bbl. Other analysts have put forward the case that, for noticeable levels of supply to be taken out of the market, the price of oil needs to fall as low as $30/bbl.
Whatever the case, it’s widely accepted that the price of oil will fall to $40/bbl before heading higher again.
Not all bad news
For pure exploration and production companies, like Genel Energy, Enquest, Tullow Oil and Premier Oil, a low oil price is disastrous. However, for big integrated oil companies such as BP, Shell, Total and ExxonMobil, low oil prices are not a huge problem.
Indeed, as oil prices fall, refining margins are exploding with the average European refinery has reported a five-fold increase in profits over the past three months. Shell and BP have both reported four-fold increases in refining profits.
Refining arms, which used to be an afterthought for big oil, are now responsible for the majority of the industry’s profit. Profits from refining contributed 80% of Shell’s and 73% BP’s first-quarter net income, up from around 20% last year.
The bottom line
Overall, with supply outpacing demand, it doesn’t look as if the price of oil is going to rebound any time soon. Unless demand starts to pick up, oil will continue to decline, and many analysts see the price falling to $40/bbl or even $30/bbl before the market begins to rebalance. It’s inevitable that some companies will go out of business along the way.
However, over the long term, as the supply of oil declines and demand continues to increase, oil prices should head higher once again. The long-term investor has nothing to worry about.
