Oil has been the talk of the investment world for about six months now, as prices have fallen nearly half since the summer of 2014. Overwhelming supply and lagging demand seems to have caught up with the markets, as producers in the US and Middle East continue to pump oil with reluctance to cut output, in fear of losing market share. Additionally, a strengthening US Dollar has put the squeeze on oil, further helping prices fall. While oil has recently seen a relief rally, many widely see the recent rally as a “dead cat bounce”, meaning the selling will resume. Citigroup slashed its oil price target to $20 about a week ago and Gary Shilling released an article on Bloomberg this morning forecasting $10 a barrel for oil.
Slowing Chinese demand and conservation measures in US aid lower oil
Shilling starts his defense by highlighting the fact that US GDP growth has averaged only 2.3% a year since the end of the Great Recession, which is certainly fairly weak compared to historical standards. Furthermore, with vehicles continuing to improve gas mileage offerings, there is less of a need to fill up at the pump as often.
Furthermore, Shilling highlights the fact that China’s once robust economic growth has been steadily slowing, The European Union is facing very minimal economic growth and Japan’s economic growth is negative. In short, demand for oil is extremely low compared to historical standards. In fact, OPEC placed oil demand for 2017 at a 14 year low of 28.2 million barrels a day and a 2015 demand figure of 29.12 million barrels, a 12 year low. Meanwhile, output is through the roof, as US shale producers are producing the most oil in the US in decades. This aspect has certainly hurt OPEC’s ability to manipulate oil prices and the reluctance to cut output is further adding to the supply glut, as member-nations fear of losing out on market share.
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Shilling: “global oil output will no doubt rise in the next several years”
Shilling further supports his call for $10 a barrel of oil by highlighting a research study conducted by Wood Mackenzie, which showed that of the 2,222 oil fields that were investigated around the world, only 1.6% would face negative cash flow if oil prices were at $40. This data suggests that oil producers will continue to see limited pain, enough to continue running rigs. Shilling further highlights the prospect of oil production in the US rising by an additional 300,000 barrels of oil a day over the next year. Additionally, a recently Iraq-Kurd deal will send an additional 550,000 barrels of oil into circulation, further dragging on prices.
Overall, oil certainly is looking bearish, but Mr. Shilling has certainly been wrong before. Shilling forecasted that the US would fall into recession in 2013 and a 43% drop in the stock market during 2012. Unfortunately for Shilling, stock markets rallied and rallied, giving phenomenal gains during 2012-2013. However, oil certainly has a major supply and demand issue that will not be an easy, overnight fix. We will see what happens next for oil and Gary Shilling’s prediction.
Disclosure: short oil