Crystal Gazing: Oil in 2016

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Pick a card, any card, and don't show it to the magician.  Now shuffle it back into the deck.  Wait for the right words and the right gesture, then the magician will pull the card out and proclaim that oil will hit $70 per barrel by 2016.  It's a trick that will delight some investors and dismay others, but one thing's for certain: the magician will never reveal the secrets of their act.  Or at least, the magician will never agree with another magician about why they chose that card.  The petroleum market has slumped yet again after a brief surge in the summer months, turning what appeared to be a 2015 rebound into a mirage with no net gain.  Crude trades for just under $50 per barrel, suggesting that the low point hit during the crash of 2014 is here to stay for the immediate future.  What do the tea leaves suggest about the performance of oil in the near future?

The Setting Sun

For the briefest of moments in time, the United States took the lead as the world's largest oil producer based on the production of shale oil that turned profits at above seventy to eighty dollars per barrel.  Those good times, fueled largely by the exploitation of the Bakken shale reserve in the Dakotas, have fallen by the wayside.  Even as the United States pumps half a million barrels of oil per day out of shale bedrock, boom towns are turning to ghost towns while petroleum jobs dry up across the Great Plains states that contain the black gold.  While the decline and fall of the shale empire takes up most of the headlines, investors should remember that conventional oil drilling (surface, deep-well, or offshore) accounts for 90% of the world's oil consumption.  Furthermore, the decline of conventional oil drilling must be factored into future oil prices since no well pumps forever.  The broad trend of oil companies sitting on their assets rather than investing in new surveying and drilling projects will cut the global output of crude by about four million barrels per day, putting valuable pressure on petroleum as demand continues to ramp upward.  Look no further than the Iraqi oil ministry announcing they would suspend field development spending; oil contractors must either forward the costs themselves or limit the supply available to their customers.  The downward slide of crude output, from conventional as well as fracking wells, leaves about a 10% gap between projected supply and existing demand, let alone projected demand.  From this gap comes Kemp's bold prediction that oil will grow by anywhere from twenty to thirty percent in 2016.  A number of voices in the crowd suggest they're not wrong.

OPEC's Opportunity

No other institution in all of human history has devoted more effort to the interpretation of oil prices than OPEC, an organization that some consider may be unraveling because of the tremendous pressure on crude.  While the richer OPEC nations have the reserves of both petroleum and cash needed to weather the storm, others have looked to supress supply and raise prices artificially, creating a harsh contrast between the haves and the have-nots of the confederation.  Has the unhappiness between the both parties led to cracks in the seams of the largest energy organization in history?  Not according to the horse's mouth.  OPEC released a report at the end of August stating that 2016 would be a tremendous year of opportunity for the nations of the bloc, with depressed US supply leading to increased demand for their product even as the Chinese market slowdown continues to affect the price of commodities.  OPEC says demand will spike to 30 million barrels per day for the first time ever, as well as confidently stating that no other supplier will be able to fill the gap.  The organization predicts all non-member states will only be able to increase production by 160,000 barrels overall, compared with 2015's record haul of nearly 900,000 barrels more from the prior year.  A great deal of this deficit comes from the US shale slowdown, believed to be slowing by 3000 barrels per day -- a rate that would nullify the total US shale oil production in under a decade.  The International Energy Agency isn't quite as optimistic as OPEC, but by and large agrees with their overall picture on the competition.  The IEA believes that non-OPEC states will see the steepest decline of petroleum output in two decades comes 2016. 

  • The Takeaway: the horizon looks far away and rather puny at the moment, but it's quite clearly there.  Each day that crude trades below $70 per barrel (ten months and counting) represents a loss for the domestic shale oil industry and a boon for overseas petroleum production.  While some OPEC states will aggressively turn on the taps next year, most notably Iran if sanctions are lifted via their nuclear agreement, the ongoing decline of US, Brazilian, and Russian oil is leading up to a fantastic market pinch.  Investors have two choices for oil: long the commodity for delivery 6 to 12 months from now, or buy at current prices (outright or through index funds) and sit on crude until the pendulum swings in the opposite direction.
  • The largest oil bears are down on buying thanks to China.  Yet the bears ignore that India has already replaced China as the world's fastest-growing economy and that the south Asian nation requires a vast quantity of crude in order to keep their economic miracle growing.  Other rapidly-developing nations (referred to as 3G nations) like Indonesia, Vietnam, Egypt, and Nigeria will also need to import huge amounts of fuel, making the picture particularly less grim than pessimistic economists suggest.

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