2015 didn’t follow the script.
After oil prices started to fall in late 2014, U.S. shale producers were supposed to freeze in horror. They were supposed to curb output and let the Organization of the Petroleum Exporting Countries seize back the initiative on oil prices. They were supposed to die, or be bought out, en masse. It was all supposed to set the stage for an oil price recovery in 2015.
It didn’t play out that way: West Texas Intermediate reached $36.01 yesterday in after-hours trading, and Brent fell to $36.49. Oil hasn’t seen these levels since the financial crisis. Sub-$30, or even sub-$20 prices are being contemplated. The world remains oversupplied by somewhere between 1 million and 2 million barrels per day (bpd).
So what’s in store for 2016? After a deviant 2015, there’s ample room for skepticism about any forecasts. Here are five questions about what oil could do this year.
Q: How low and for how long?
It’s now an industry cliché that prices will be "lower for longer" than expected. Where experts differ is on what that means.
Right now, conventional wisdom on Wall Street is that prices may continue to drop in the first half of this year — even below $20 or $30 for spells — but that they will hit bottom. U.S. crude production would continue to fall, and the world would work off more of its oversupply. That would set up a price rally in the back half of the year.
"Rally" doesn’t mean much these days. Forecasts for the fourth quarter of 2016 range from the low $50s to the mid-$60s.
The real question is what happens next. Is $100 or $150 oil in the cards someday? Possibly — anything’s possible in oil! But not probably.
The International Energy Agency sees the international price benchmark, Brent, no higher than $80 per barrel by 2020. Even the reliably sanguine OPEC has said oil won’t top the $80 mark this decade.
The reasons are many, but a major one has to do with a certain shale patch in the northern Great Plains.
Q: Has U.S. shale put a lid on oil prices?
A year ago, it was thought that shale would shrivel at prices under $60 or $70 a barrel. But U.S. producers cut costs 25 to 30 percent over the span of 2015, proving they can work with a lot less.
Is it sustainable? Analysts think not, but U.S. crude output is still well above its 2014 levels. When it finally dialed back last summer, it was by about a half a million barrels to just over 9 million bpd. This doesn’t even count the thousands of wells in the "fracklog" that the industry can tap within months, if prices encourage it.
That’s a potential problem for OPEC — and the whole oil industry. It means that anytime prices rise even a little, U.S. shale firms can sweep in, sell barrels for that higher price and send prices back down again.
"Higher prices would stimulate significant new shale supply — though there may be some frictions to restarting idled production activity — and act to cap prices from rising too far above $70," Citi analysts said in a November report.
If shale has elbowed out a new position in the middle of the global supply curve, serious questions will have to be asked about higher-cost projects.
One hundred fifty projects have already been put on ice, according to Tudor, Pickering, Holt & Co. A fifth of them are in Canada’s oil sands.
Q: Will OPEC buckle?
Last year was filled with drama within the world’s major oil-producing cartel, with poorer members begging the well-heeled Persian Gulf states for some kind of action to kick prices up.
But no such action came, and no one sees OPEC turning back now. None of its incentives have changed: If prices rise, shale gets the prize. Only with today’s calamitous prices, OPEC’s leaders hope, can it discourage the competition and maintain market share.
And so OPEC continues to exceed its supposed quota. Iraq ramped up production, after deflecting the Islamic State group. Saudi Arabia’s production peaked last summer around 10.5 million bpd, according to Credit Suisse. Iran may add to OPEC’s glut, if its nuclear accord proceeds as planned.
"The greater risk in 2016 again lurks on the supply side," Credit Suisse analysts said last month. "It is that of Saudi Arabia keeping its foot down and raising supplies into the market still further."
Saudi Arabia’s campaign has been costly: Its 2015 budget was nearly $100 billion in the red, according to "Nightly Business Report." Venezuela, Libya and Algeria need even higher oil prices to balance their budgets, which suggests OPEC members will have more passionate debates this year.
Q: Will China (or anyone else) ride to the rescue?
Monday’s stock flub shows how jittery the oil markets get about the question of demand. China signaled in 2015 that it is, at least temporarily, taking a breather as the oil market’s best pal. It’s trying to shift from an industrial economy to a more consumer-led one, and markets still don’t know if the good times are over or if more are to come.
Worldwide, oil demand is actually growing. It rose about 1.8 million barrels a day in 2015, according to IEA estimates. More growth is expected in 2016, with consensus in the 1.2 million to 1.4 million bpd range, according to Capital Economics.
The question is whether that’s enough to perk up prices. One thing’s for sure: Oil prices will flail in response to demand signals, as the market tries to figure out what’s for real and what’s not.
Q: Is oil in a new world, or have we seen this movie before?
Already "rerun" theorists are positing that oil will spike in the next two or three years, possibly to levels that would seem laughable today.
The idea — advanced by the CEOs of Schlumberger Ltd. and Total SA, among others — is that today’s low prices are choking off investment. But rocks need constant investment in order to produce, so their production will decline in the coming years. If that happens to enough rocks around the world, even U.S. shale won’t be enough to fill the gap. The world will find itself in a shortage. Prices will skyrocket (EnergyWire, Sept. 10, 2015)
The laws of supply and demand could be content with that outcome, although it would be more jarring for humanity. Still, there are those who wonder if the fundamentals of the oil world have changed.
Take Spencer Dale, BP’s chief economist, who argued in an October paper that shale and climate change are two factors that have permanently altered the playing field.
Shale and other unconventional resources mean "it is increasingly unlikely that the world’s reserves of oil will ever be exhausted," Dale argued in a paper issued by the Oxford Institute for Energy Studies. And in the long term, he said, climate policies could constrain demand.
"There is no longer a strong reason to expect the relative price of oil to increase over time," he said.