Tags: oil | price | commodity | shale

How to Know When Oil Touches Bottom

By    |   Wednesday, 03 December 2014 08:11 AM

No one rings a bell when the stock market hits a peak or a bottom. Major turning points are usually evident only in hindsight. The same is true for energy prices.

Last week I wrote OPEC Is Collapsing, with Oil Prices Right Behind. The timing was even better than expected. I was correct to think that OPEC would not reduce production quotas, but wrong about the immediate impact. I thought traders had already built a "no-cut" scenario into the oil price. I was completely wrong.

On Wednesday, Nov 26, spot West Texas Intermediate crude settled at $73.69. It ended the week at $66.15 for a 10.2 percent drop in two days — and it was really one day since OPEC made its decision Thursday, a U.S. market holiday.

Commodity prices do not move that far and that fast unless something unexpected occurs. Clearly, many oil traders expected a different outcome. They were betting on hope, but hope disappeared.

Where does oil go from here? The best-case scenario is that last week's plunge was a selling climax and energy bulls capitulated. If so, we should see some stabilization and possibly a slow recovery.

That is the best case. The more likely case is that crude oil will keep falling after a brief pause, and then bottom out far lower than anyone currently expects.

Like everything else, commodity prices are a function of supply and demand. The demand side of that equation is flat or falling. Prices will stay low or go lower yet until something reduces supplies. What will it be?

A geopolitical event might work. The Middle East is certainly a cauldron right now — but it always has been. The usual general anxiety won't do the trick. Something would have to score a direct hit and immediately reduce oil shipments. It could happen, but the odds are very small.

More realistically, oil prices will go back up because production levels fall significantly. The problem here is that no one wants to cut. The Arab members of OPEC aren't going to cut. The cartel's poorer members — Venezuela, Nigeria and Angola — can't afford to cut. Putin has no plans to reduce Russian production. So who will it be?

The remaining candidate is the U.S. oil industry — and our wildcatters are still talking tough. Oklahoma billionaire Harold Hamm, founder of Continental Resources (CLR), said just last month he was so confident prices would recover that he was liquidating all the company's oil hedges.

That was a big mistake. Hamm is still a billionaire, but his company is about 20 percent less valuable now.

Hamm isn't the only one. American oil execs are putting on brave faces and vowing to push on. Many claim they can still make money with oil as low as $60 to $70 a barrel. They might be right, but they will make considerably less money than they did when oil was $100.

"We're breaking even!" is not the kind of statement that impresses rational investors.

I think oil will keep falling until the U.S. shale industry surrenders. We need to see projects cancelled, drilling suspended, pipeline construction cease and operations closed. It will be painful for many people, but that's what it will take.

We will know oil's bottom is near when people stop saying things like "Drill, baby, drill!" and "We can still break even." If you are in the oil business and you want to survive, I suggest you erase those phrases from your vocabulary.

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No one rings a bell when the stock market hits a peak or a bottom. Major turning points are usually evident only in hindsight. The same is true for energy prices.
oil, price, commodity, shale
578
2014-11-03
Wednesday, 03 December 2014 08:11 AM
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