With oil trading at roughly $30 per barrel at the time of writing, there’s real fear among investors that its price could move lower. After all, the price has collapsed from around $115 per barrel in 2014 to as low as $27 per barrel earlier this week. And with a number of commentators now stating that oil could fall further to $10 per barrel, panic has well and truly set in.
Undoubtedly, the oil price could continue its slide and after falling by such a vast amount in recent months, $10 per barrel is achievable. That’s at least partly because there’s no sign the supply glut that has been the major reason for its fall could end soon. For example, Saudi Arabia has recently refused to cut supply and is apparently willing to let oil keep on falling in price to put greater pressure on US shale producers.
Furthermore, with Iran’s sanctions being lifted, it will flood the market with an additional 500,000 barrels of oil per day, which will have a further negative impact on its price. And with a number of recently-reporting producers saying they’re profitable at current oil price levels due to savage cost cuts, there’s an incentive for them to increase, rather than decrease, production. In other words, they’ll naturally try to maximise profit by producing more, which leads to even lower prices, then more production and so on.
Rewinding back to the credit crunch, the price of oil reached a low of just over $40 per barrel in early 2009 before rebounding strongly to over $115 per barrel in early 2011. Clearly, a similar rise is possible this time around, but the factors causing a lower oil price are rather different.
The China syndrome
Back then, there was a real fear that the global financial system was in meltdown and that the world economy would sink into a depression, leading to lower demand for oil. That didn’t happen because of government action in the developed world and also because China continued to grow at a rapid rate. Today, oil is low partly because of fears surrounding Chinese/global economic growth, but also because of the aforementioned supply/demand imbalance.
As such, in order for oil to rise there must be a reduction in supply because demand is unlikely to pick up the slack in any time period but the very long term. For example, by 2040 it’s estimated that global energy demand will be 37% higher than today, with oil and gas still set to be a major part of that mix. So while demand for oil is likely to increase, spurred on by rising demand from emerging economies, this is likely to be something of a ‘slow burner’ in the very long term and is unlikely to cause a rebound in the oil price over the next few years.
Therefore, with the prospect of increasing supply in the short run, a lower oil price is on the horizon. However, there will come a point where it becomes simply uneconomic to produce at a given price. At this point, consolidation, reduced production and a rising oil price are likely. Because of this, buying oil stocks now could prove to be a sound move for long-term investors, although there remains significant risk of further falls in the price of black gold over the coming months.
