Could Oil Drop As Low As $20 A Barrel?

Don’t bank on any quick oil price recovery!

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With Brent Crude slipping back below $37 a barrel, close to 11-year lows, the question at the end of 2015 is whether the precious liquid could slip as low as $20, as some analysts have been touting. And the short answer is, yes, it could.

Part of the problem has been a disjoint in the usual relationship between supply and demand, and for a long period in 2015, while the price was falling, supplies were actually increasing. Major oil companies around the world were mothballing some of their more expensive developments, but Gulf producers were having none of it and were keeping production high, while other countries like Iran are starting to add to the global glut.

Free market

With the demise of any Opec control, we’re certainly in a freer market for oil prices now, so could the stuff just be settling towards its free market pricing? It almost certainly is, and right now we’re probably still some way from an equilibrium that would give us any idea of longer term prices.

BCA economist Dhaval Joshi, reported by the Guardian, reckons we’re in the third major period of commodities deflation of the past century, and predicts that oil could drop to around $25 a barrel before it bottoms out.

Having said that, recent data from the US Energy Information Administration showed that American oil stockpiles actually fell by about 5.8m barrels over the year, which is better (for the oil price at least) than the predicted rise of more than a million barrels, so there are signs that the oversupply is being reduced in some markets.

Uneconomic

Then there’s the actual break-even cost of getting the stuff out of the ground, and many oil producing countries — including even Saudi Arabia — are unprofitable at current prices. The IMF has even gone as far as to suggest that Saudi Arabia could be bankrupt in five years if its current economic policy remains unchanged, although this week the country has maintained its insistence that it will keep oil production levels high.

In the longer term, the inverted demand/supply relationship is not sustainable, and with oil demand expected to rise significantly in the next five years, some are calling the bottom even now, and suggesting oil will start to creep up again during 2016. Opec itself has suggested that oil should recover to around $70 a barrel by 2020, with energy demand rising by nearly 50% by 2040. I really don’t think there’s anyone would would seriously argue against a recovery to at least $70 levels over five years — in fact, many investors would see such a slow recovery as very bad news.

Crunch

Next year should be a crunch year for shale oil producers too, and oil prices at today’s level would push many of them to the wall should they continue for too long — even if the industry is becoming more and more cost efficient.

By the end of 2016, I’d be very surprised if the oil price is not significantly higher than it is today — $50 a barrel at least, maybe $60. But in the next few months, there’s a serious chance that it will fall further before turning back up. And I really wouldn’t bet against those feared $20 levels.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Alan Oscroft has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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