How low will oil go?
I tried to avoid this answer for many reasons. My hesitancy in answering is due to my jagged edge of experience in trading commodities. The price of a commodity, in a fixed given time period, does not have to hold any fundamental characteristic. In today’s world of constantly being “online”, traders chase the next move through any means including reading into a statements made by OPEC members. As much as today’s spot price of oil predicts the price of oil 6 months from now, the same applies to the futures market price (How much? Answer: Not Much).
The price now for oil, whether spot or futures, represents the condition of buying, selling, and managing internal storage with a system of risk of tomorrows price. If the market believes the oil prices can go lower, you have fewer buyers as they would rather use their inventory until a point the price holds too much risk it will be higher. If the market believes the oil prices will go higher you have more buyers wanting to build inventory and will buy it to the point the price holds too much risk it will be lower. There are losing and winning trades throughout the year.
Right now you have a bunch of “losers” who have locked in oil prices at way higher prices. Hedging is dangerous when your market competitors don’t and your prices for your service/product can be eroded by competition. There is not much intelligence when one hedges all your volumes at once. A balanced hedging program should step into the changing markets. An effective oil hedging program would have allowed the market to fall while gradually adding to the hedge over time. Calling the bottom of the oil price would be as lucky as trying to catch the handle on a sharp falling knife from a 10 story building. It is possible, but not likely. An effective hedging program would let the knife fall and realize you won’t catch the bottom, but you won’t ignore it either.
The bottom price of oil will likely not occur without an event. Traders need to see the market is responding before stopping the momentum of a falling knife. Unfortunately, the oil markets are operating on sunk cost investments. A reaction on drilling and production will take time. I believe one of the first signals for a slowdown of production will not come from the physical production declines, but from the insistence of the debt holders to quantify what they own. The operating company management team will likely go ahead and produce whatever they can – the debt holders will want them to stop so they quantify the volumes and use those volumes to payback the debt. This will take time to play out via bankruptcy. The other reaction to low prices will come from the demand side. This is winter for the largest consumers of petroleum. Demand can only rise so much now. However, as we move into spring and summer, expect a rebound in demand. The ironic statement is that the current market is not so trusting of the market to react.
Oil prices can continue to fall. However, as a business, I would not be planning based on this market aberration. The fundamentals will re-align the markets as real data and information becomes available, and actions by participants occur. This could take as long as 6-12 months. I still believe oil prices due to the global nature realign itself in 6-12 months north of $60/bbl. Some have tried to compare the drop in oil to the drop in US natural gas price, which has not really rebounded. However, US natural gas markets are not global – yet – and potentially never will be as LNG and GTL investments are likely being questioned with low oil prices. The issues we discussed that will drive this market hasn’t changed – Oil Market Doomsayer.
If you are dependent on oil prices and have never hedged your purchase, this could be an opportunity to develop a systematic method for hedging some of your oil needs. A true hedge creates a system to manage your budgets while balancing your business and energy risk. Hedging programs should never be constructed to make money or save money. If so, you are now trading, which is a valid business option if you have the appropriate experience.
Please consider All Energy Consulting for you energy consulting needs. We add insights to the energy market for your success for now and years to come.
Your Energy Analyst Not Interested in Catching Falling Knives,
David K. Bellman
All Energy Consulting LLC- “Adding insights to the energy markets for your success.”