Crude has fallen by over 60 percent since last June. I don’t recall any
analyst predicting such price capitulation. It was a rare and difficult
event to foresee and could be categorized as what mathematician Nasim
Nischolas Taleb calls a "black swan event".
With crude
prices trading at eight year lows, one of the most crowded trades still
remains a sell on rallies in oil. Every market participant is talking
about the new normal in energy prices, the shale revolution, end of the
commodity super-cycle and the beginning of the end for OPEC member
nations and their pricing power.
This column is of the view that
one of the biggest macro risks of 2015 is a V-shaped recovery in oil
prices. This scenario is not as farfetched as many currently believe it
to be. The drop in energy prices has been more a function of supply side
factors than a lack of demand. In 2014, shale production jumped by one
million barrels a day. Compare this to the average yearly growth in
global supply of 780,000 barrels per day since 2005 and one can clearly
see how the supply-demand dynamics have been affected.
However,
the supply surge may peak soon according to DBS analyst David Carbon. In
a recent research note he writes: "The US EIA estimates that the boom
in shale oil production will, for all intents and purposes, end in 2016.
Even before the plunge in crude prices, production growth was expected
to drop by more than half in 2015 and by more than half again in 2016.
By 2017, shale oil production will stop rising. By 2020, it (and total)
production will be falling again. US shale oil will remain an important
source of supply in 2020. But on the margin, the surge in US supply will
be gone by 2016." Further, in 2014, Asian demand absorbed sixty percent
of the surge in US supply. In 2015, it will ‘absorb’ 135 percent of it.
The demand-supply gap will have reversed, according to DBS.
With
oil prices plummeting below $50/barrel, the question on everybody's
mind is when OPEC will cut back on production. Till now, countries such
as Saudi Arabia have been reluctant to do so as they wanted to maintain
their market share and wanted to test just till what price level would
"shale economics" be feasible.
Recent trends suggest that we
will have answer to the above questions quite soon. US drillers have
taken a record number of oil rigs out of service in the past six weeks
as OPEC sustains its production with Brent crude prices hovering well
below $50/barrel. According to Bloomberg, the oil rig count has fallen
by 209 since Dec 5, the steepest six-week decline since 1987. The count
was down 55 this week to 1,366. Further, horizontal rigs used in U.S.
shale formations that account for virtually all of the nation’s oil
production growth fell by 48, the biggest single-week drop. Clearly, low
oil prices are testing times for the US oil production.
Nobody
complained about the fall in energy prices as it is largely a net
positive for the global economy, even taking present deflationary
pressures into account. A sharp recovery in energy prices would surely
dampen the bullish outlook on global equities, especially oil importers
such as India.
(22-01-2015. Vatsal Srivastava is consulting
editor for currencies and commodities with IANS. The views expressed are
personal. He can be reached at [email protected])
