A lower oil price is to be expected

A lower oil price is to be expected

This opinion piece is based on an interview that Erik Townsend, host of Macro Voices podcast, had with Art Berman, an American Petroleum Geologist. Art Berman created a comparative inventory price modelling system which has proven to be remarkably accurate at forecasting crude oil prices.

In the US, oil is primarily produced by either stripper production or shale (tight) oil.  Stripper production refers to oil wells that produce minimal volumes per day and are generally owned by smaller companies. Whereas, shale (tight) refers to wells that produce oil from fractures which were more recently drilled, have higher pressure and produce large quantities of oil per day. Shale oil rigs are generally owned by large companies and account for roughly 55% of America’s oil production, with stripper production accounting for the remainder.

A factor that should be paid attention to is unaccounted-for oil. This is simply oil that was produced but didn’t enter the market. Meaning that it is stored somewhere, and no-one knows exactly where. Yet, when producers feel like it, they tend to bring the unaccounted oil into the market, adding to an already oversupplied market.

The graph below shows the volume of unaccounted-for oil for the last four years.

It is evident that large volumes of oil do not enter the market. As such, an oversupply of oil can be expected globally. OPEC+ countries still produce too much oil in comparison with demand. As such, if OPEC+ countries and America have too much oil, we will see a decline in the oil price, as the storage thereof will once again become a problem.

The graph below shows the current storage levels.

With the current storage levels, a price decrease in the range of $20-$25 per barrel can be expected as the economy is not recovering as initially anticipated. More stringent lockdowns are being implemented again as the second wave of COVID-19 is appearing in several US states. As such, a slower economy can be expected.

Many believe that producers of oil receive the amount of money that oil is trading at per barrel. This assumption could not be further from the truth. Most producers hedge the price of their oil, so even if oil is trading at let’s say $20 per barrel, they might have hedged for $35 per barrel, and will thus receive the $35. Generally, the producers that hedge their oil price are the same ones who can easily turn their wells on and off along with market movements. The only reason they initially turned off their wells during the lockdown was that they had no storage space for the oil they produced.

The graph above depicts the current Brent Crude oil price at $43.12 per barrel. However, based on the discussions above, a decline in the price is to be expected. The bottom line here is that the economy is NOT recovering as initially anticipated. Art Berman believes that in the short- to medium-term, oil prices ranging between $20-$25 per barrel might be very realistic. As such, it is advised that companies making use of oil in their productions, should strategically hedge against the oil price, as a lower oil price is expected given all the economic activity at the moment, coupled with weaker global demand.

This opinion piece was researched and written by the TreasuryONE Dealing Team. You are welcome to phone or email us and discuss your view on the topic.