What we've seen over the last 8 months has been ailing economy's in Europe and China. Both these economy's play a significant role in the purchase of oil, China being the emerging source of demand. We've also seen Russia being sanctioned from the US and Europe which has left Vladimir Putin in a very precarious position of trying to manage a Russian economy fraught by declining sales of oil coupled with price decline.
However the main focal point taking centre stage is that of the US shale gas drillers competing against OPEC. The US has gone on an impressive yet typical capitalistic drive to become self reliant on it's own source of fuel from which it has for many years complained about OPEC's dominance within the world oil market. OPEC has in return retaliated by increasing the supply of all it's member nations. The result has left world oil prices at 50% lower than they were a year ago.
There's been much excitement from consumers as they've seen their spending power increase in a short period of time and for some a relief , however some economists have warned against becoming comfortable with a lower oil price and indicating that there could be a short term bounce. How certain are these forecasts? Lets explore some of the possibilities of what could unfold in the coming months.
The chart above is that of Brent Crude Oil on a Monthly basis over the last 7 years. We see the large symmetrical triangle in place which broke to the downside, which led to an ensuing price plunge. The target of the technical shape has been met but it must be added that the price also came very close to the lows we saw in 2009 when there was a previous bubble.
The candle we see currently is the first green candle in 8 months. The length of the candle does indicate strength from buyers and should the price close above the previous candles high it could signal a reversal of the price action. If we observe the extent of the fall we can see that the rate of decline is unsustainable and in saying that, we would expect the price to retrace back some of the move and that the plummet in the price was an overreaction.
Let's consider this for a moment, US shale drillers have incurred large amounts of debt to construct wells which is why the cost of production is quite high, anywhere in the region of $60-70 a barrel. If the price were to stay below these levels, drillers would be forced to turn off wells because they would be making a loss. We have seen over the past few weeks the number of operating wells in the US slowly decline and this would support the bounce in the price of oil.
However in order for OPEC to continue exerting it's collusive control over the oil market it wouldn't want to entertain competition from alternative producers, especially not the US, the largest consumer of oil in the world. I believe that OPEC will not allow it's production to drop and thus exert further pressure on prices. The longer they are able to keep prices below breakeven for shale producers, the worse the situation get for the creditors.
But it's not without cost as OPEC is now effectively risking the economic well being of its member nations who are already reeling with trade imbalances which gives way to a knock on effect on the overall economy. Some member nations, such as Nigeria who haven't been insulated from these price shocks are looking down the barrel of recession leading up to hotly contested elections coming up in March of this year.
US drillers have now become a ticking time bomb with many concerned parties halting expansionary processes. Close to home we've seen the likes of Sasol, who has been planning a plant in Louisiana, halt construction and more recently change it's dividend policy. All these factors point to management becoming uncertain with the oil environment over the medium term and could spell disaster for those already invested in it.
To summarize; the oil sector is going to become a pot of interest over the next few years and it's going to be a space where we could either see a shift forward in progression to new fuel or back to the same regime of being held to ransom. I believe that we will see the price subdued in the short term but further drops in the medium term. One thing is certain though, the global economy is in constant motion and dire need of a solution to the energy dilemma.
