The Oil Market Prediction Game<
Anybody who tells you they know where the oil market is headed for 2016 is inexperienced, too stupid to realize there are far too many variables in play that are unknowable to predict with any accuracy their effects on other variables in the oil equation, talking their own respective books, just piling in with the recent herd mentality on the street, giving an opinion about as valid as the best paint color for a room, or like to see themselves on television talking about the hot market moving topic du jour.

The Oil Market
The Oil Market

If Experts were paid for Accuracy

 

We have written extensively on the topic, have a lot of experience in the industry, were right regarding the direction, but frankly wrong about the timing of the inevitable market correction. I remember reading all the comments at the time of our analysis with reactions such as “Shale requires $80 a barrel oil prices”, or “OPEC needs $85 a barrel oil prices so oil can never go lower than $85 a barrel”, “Shale wells depletion rates mean…”, and “China is going to use so much oil that…”. I have to sit back now and smile when IHS, Goldman Sachs, and the IMF or any other oil analyst gives their predictions for the price of oil for the end of 2016.

 

Just look at all the predictions at the start of 2015 for oil prices by year`s end? Most analysts saw oil prices being weaker the first half of 2015, only to rise by the third, and be even higher by the 4thquarter of this year. I would say most analysts had the price of oil much higher than $55 a barrel by year end if we made them commit to a price at the beginning of 2015. Well we aren`t even going to end the year above $40 a barrel.

The Oil Market
The Oil Market

Futures Curve

 

And similarly don`t look for the oil futures curve to be any better predicting future price points in the commodity as just look at where it was priced right before the turn in oil markets in 2014. The futures curve has basically become a lagging indicator of a lagging indicator, basically mimicking the current sentiment in the market and extrapolating out the curve. It is about as useful as a personal psychic reading is in predicting one`s future course in life.

The Oil Market
The Oil Market

Dependent Variables

 

There are just too many variables that effect other variables within the oil market dynamic to determine with any accuracy where the price of oil will be by the end of 2016. If two variables go one way instead of another, they affect other dependent variables, causing a whole cascading effect which leads to an entirely different outcome. And the problem with the oil market is there are in excess of 10 extremely important variables that if any one of them goes offline or different than the consensus forecast this throws the entire oil market equation analysis game completely off course.

The Oil Market
The Oil Market

The Oil Market  – Unknowable Assumption

 

Consequently if one starts with the premise that the price of oil is unpredictable for 2016, then what do we know? Where can we at least have a foothold for pretty reliable assumptions? Well let’s start with this, we know at some price oil operations will shut down. What price does oil need to go to before oil operations shut down? Moreover, that such money is lost that banks will not finance operations even if oil prices rise because they realize that this would just bring new production online only to have oil prices fall again, and they lose money all over again.

The Oil Market
The Oil Market

The Real Pain Threshold

 

Thus it isn`t can an outfit make money for six months or a year, but can they make money for 10 years, can they withstand a downturn in prices? There will be a much higher bar for lending just like the end of the no down payment loans in the real estate sector. This probably means there needs to be a whole lot more pain in the credit markets where even if oil rises to $55 a barrel it doesn`t mean one is getting a loan to start pumping again only to have oil fall due to more shale production going back online.

 

I would surmise that around $20 a barrel major money is lost, and lost fast with major credit events bringing about so much destruction and pain that lending decisions aren`t based on where the price of oil is for six months but can it average such an such a price for 5 years without an over glut in supply happening all over again. Therefore I am latching onto the $20 a barrel floor because of the idea that production goes out of business at this price, and stays out of business the longer duration oil hovers around this level.

The Oil Market
The Oil Market

Long-term Project Evaluation Metrics

 

At this price it doesn`t matter whether oil will rise back to $55, if enough money is lost at $20 a barrel, this is a major deterrent for future projects going back online without an outright raging bull market in oil. The way oil projects were viewed after the oil collapse in the 1980s, conservative lending environments with 10 year time horizons required and supported by a consistent cash stream of average oil prices well above production costs for the project on a 10-year going forward basis. Just because an oil operation can make money for 6 months isn`t a reason to provide lending for said oil operations, and banks are going to start getting this principle.

The Oil Market
The Oil Market

 

Unknown Variables: US Production

 

An example of an unknowable variable in the oil market is what happens to Shale oil if oil gets down to $20 a barrel? Does US Production drop off a cliff to 6.5 – 7 Million barrels a day? Does it go even lower, say 5 million barrels a day? And how fast does this happen? You see how one variable is dependent upon another variable. These two concepts of speed and depth of the fall in price are inextricably linked in the equation; and they are completely unknowable in my opinion.

 

 

The Oil Market
The Oil Market

Saudi Arabia

 

Another unknowable variable is how do the budget changes in Saudi Arabia just two years after the Arab Spring, and cutbacks in government subsidies to the general populous affect political stability in Saudi Arabia? This hasn`t occurred in the modern era of Saudi Wealth and this generation of always having ample resources and strong pricing power for their main funding source as a country. Just imagine all the London shops, hotels and medical facilities all courting

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