American Oil and Gas Reporter - October 2015 - 36

MARKETMATTERS
Bulls And Bears
Draw Different Conclusions
From Price Patterns
Crude oil prices have followed a distinct pattern in the years
since 1985. Erosion of crude oil prices has been followed by strong
recoveries, often leading to new highs. The most recent drop and
recovery have not been in that mold, reflecting changes in costs
resulting from new technologies and changes in OPEC's strategy to support prices.
There have been five substantial crude oil price declines since
1985. The first moved prices from $31.50 to $9.75 in April 1986,
followed by a 76 percent recovery the next month-an increase to
$17.20. The drop in 1990-91 caused prices to reach $17.45 with
a subdued recovery of 39 percent. More impressive was the recovery at the turn of the century following a fall to $10.65 in December 1998. By March 2000, prices had added 222 percent to
value, rising to $34.25.
The financial crisis of 2008 saw crude oil prices reach
$147.27, followed by a spectacular plunge to $33.20 as 2009 began. By May of that year, values had doubled, topping at
$66.64. The most recent erosion of West Texas Intermediate prices
went from $107.73 in June 2014 to $43.58 in January of this year.
The bounce that followed was modest by comparison, adding 44
percent to value and reaching $62.58 in May. Prices have since
lost all the gain and were back in the mid-$40s in September.
Traditional analysis of oil markets had many analysts forecasting recoveries back into at least the $80 range, but the changing landscape has split the analytical community into bullish, bearish and neutral camps. New technology and attempts to keep prices
lower by maximizing production are new factors to be considered
in projecting price. They have led to wildly different expectations.
The bearish case has been characterized as "lower for longer."
Bearish analysts now expect crude oversupply to last through 2016.
Several reasons for this have been proposed. High crude oil inventories can be expected to persist because OPEC production
growth will continue to contribute to oversupply. Another bearish consideration is that sunk investment costs will allow nonOPEC, non-U.S. production to advance.
Supply surplus can remain the barrier to price increases because global demand growth has been faltering. In particular, China has experienced a slowdown that impacts crude oil demand.
Moreover, Chinese demand loss carries over to its suppliers with
their own demand.
The supply imbalance has led to lowered price expectations
among bearish analysts. One leading group has reduced its forecast for 2016 to $45 from an earlier expectation of $57.
Lower prices and selling into an already overstocked market
could affect the financial condition of producers and cause some
to suspend activities. This could contribute to reduced output levels and ultimately return the market to balance. Along the way,
however, achieving balance may prove difficult, reflecting
changes in improved efficiency. Oversupply will clear at some
price, but that price could be in the $20 range in the current sitTransactions in securities futures, commodity and index futures, and options carry a degree of risk. Past
performance may not be indicative of future results. This column is for informational purposes only. It does
not represent an investment offer, solicitation or recommendation.

36 THE AMERICAN OIL & GAS REPORTER

" The changing landscape has split

the analytical community into bullish,
bearish and neutral camps.

uation.
Price bulls are taking the view that the markets will improve
in 2016. They believe the market is not nearly as oversupplied
as many believe. This reflects the idea that measures of oil supply do not accurately reflect availability. They are based on total supply of liquids, implying that all oils are fungible.
In reality, refiners manufacture the product most needed and
most profitable. This creates wide variations in crude oil balances.
Moreover, the idea of oversupply often does not consider base
stock loads or seasonal stock variances. If this is so, the idea of
a price recovery is not excessive.
Moreover, refining capacity is growing and opening the market for crude oil. Refineries are operating at high rates, especially
for gasoline. If demand grows, price bulls see equilibrium returning
late in 2016. Bullish analysts expect prices to recover toward $85,
basis Brent, by 2018.
Potential risks to this bullish scenario include a slowdown in
the economy or further appreciation of the U.S. dollar. Larger than
expected additions from Iran-if it is able to solve infrastructure
problems-would be bearish in the long term.
Shrinking supply may become a factor for natural gas as well.
According to the U.S. Energy Information Administration, production from the seven largest U.S. shale deposits has started to
decline. Falling output is expected for October, which would provide four straight months of decline, the longest period of declines
since 2007. The decline has been most important in the Eagle Ford
formation.
Pipeline limitations are cutting into natural gas output as well.
Appalachian yields are falling. The Marcellus Shale will lose about
500 million cubic feet a day of output in 2016. Some analysts estimate supplies will "finally fall short of demand" next year. r

ALAN H. LEVINE is chairman
and chief executive officer of
Powerhouse, a registered affiliate
of Coquest Inc., and a commodities
brokerage offering hedging services to the energy industries.
Levine has more than four
decades of experience as a petroleum specialist. He may be
reached at alan@powerhouseTL.com or 202-333-5380.

American Oil and Gas Reporter - October 2015

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