The Fuse

Oil’s Price Floor Still Elusive

by Matt Piotrowski | August 14, 2015

Oil markets have yet to find a bottom. The decline that began in June 2014 when Brent reached $115 is still not over, with prices reaching a six-year low this week, and it’s unclear when it will end. There are really only bearish indicators on the horizon, with OPEC pumping at record highs, U.S. producers continuing to show resilience, the Chinese economy slowing down, and the U.S. dollar remaining strong. But most of these factors have already been priced in, and the Brent market is nearing key technical support levels, suggesting a rebound may be in store soon. Even so, there’s so much oil in the market right now prices could be looking at even more losses.

Headline prices are somewhat misleading, as many crude grades are trading below Atlantic basin benchmarks. The market quieted down on Friday after a volatile week—North Sea Brent is now hovering around $49 per barrel and U.S. West Texas Intermediate is holding above $40. But many streams are already well below $40, with oil produced in Bakken fields trading around $30, and some Canadian grades in the $20s.

Many streams are already well below $40, with oil produced in Bakken fields trading around $30, and some Canadian grades in the $20s.

These price levels were supposed to bring about major supply losses, but so far that’s not been the case. As Bloomberg reported this week, drillers in Bakken fields in North Dakota still haven’t slowed down as costs have fallen sharply, helping them manage the current low-price environment. U.S. crude oil production is now averaging 9.4 million barrels per day (mbd), falling a modest .07 mbd week-on-week, but still some .84 mbd higher than year-ago levels. This is reflected in this week’s rig count, released by Baker Hughes, showing that U.S. oil directed rigs are up two from last week.

The EIA sees U.S. production falling for the rest of the year and through the end of 2016, a bullish development if the forecast is realized. The government agency pegs U.S. output at 9.2 mbd in the second half of this year, versus 9.5 in the first part of 2015. For 2016, production is expected to dip under 9 mbd and won’t rebound until the fourth quarter.

But the EIA’s forecast could be too pessimistic given how well the rig count has stabilized, and drillers becoming more efficient, cutting costs, and tapping large wells.

“Drilling costs are one major indicator to keep an eye on to see if prices will stay weak or weaken further,” said Tim Evans, analyst with Citi Futures in New York. “Drilling costs have come down dramatically. We’re hearing the best wells can still get a 10 percent return with prices at $30.”

Evans points out that a lower price will likely be needed to a completely choke off U.S. production, but it’s unclear what that price level is.

“Total crude oil production may decline but not fall apart,” said Evans, who also notes that refracking—fracking a well again after it has already been fracked—has improved efficiency, cut costs, boosted flows and extended periods of higher output.

The three major forecasts this past week from OPEC, the International Energy Agency (IEA), and the EIA all agreed that rebalancing will take time and the supply glut will persist through 2016. Besides the shale outlook in the U.S., OPEC supply levels will be key, with Iran and Saudi Arabia having particularly important roles.

The World Bank argues that Iran’s return to the market will add some one mbd by next year and slice oil prices by $10.

Now that Iranian volumes are increasing as a result of the nuclear deal struck between Tehran and world powers, the surplus could balloon even more. Iranian production rose by .03 mbd in July versus the previous month, a modest uptick, but it could be a harbinger of more to come. The World Bank argues that Iran’s return to the market will add some one mbd by next year and slice oil prices by $10. The EIA, taking into consideration Iran and other bearish factors, cut its forecasts for Brent for this year and 2016 by $6 and $8, respectively, in its monthly report put out this week.

What could turn the market around?

With the market clearly cloaked in bearish sentiment at the moment, is there anything to turn prices around? Saudi Arabia holds the cards in this respect. The kingdom last year abdicated its role as swing producer and chose to compete for market share rather than cut back on production. Despite this course of action, Saudi output of above 10 mbd throughout the second quarter still caught the market by surprise. “The Saudi strategy is a significant part of the current oversupply. If the Saudis change course, it would definitely be a bullish signal,” said Citi’s Evans.

A Saudi cutback in output to shore up prices is not likely now, but the tougher the environment becomes for producers, the greater the chance that there could be a coalition between OPEC members and non-OPEC producers to throttle back. A coordinated cut of this kind has been discussed among various parties since late last year, but analysts do not see it as a possibility in the short run.

Technical indicators

The next key technical level on the downside for ICE Brent is $45.19, the low trade in January. If the market can hold above that indicator, prices could be in store for a short-term rebound. However, a break through that level could prompt another wave of selling and more losses. For WTI, the longer-term key support is $32.40, the low trade in December of 2008. A retreat to that level would make a lot of producers very nervous indeed.