Why T. Boone Pickens And Others Keep Getting Oil Price Estimates Wrong

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Includes: BNO, DBO, DNO, DTO, DWTI, OIL, OLEM, OLO, SCO, SZO, UCO, USL, USO, UWTI
by: Gary Bourgeault

Summary

Why historical oil benchmarks no longer work for price projections.

The specific disruptions in the oil market that changed everything.

One thing that hasn't changed and needs to be considered in all oil analysis.

Demand will continue to disappoint to the down side through 2016.

Storage secret most investors are unaware of.

A while back T. Boone Pickens made a projection that the price of oil would reach $70 per barrel by the end of 2015. It wasn't even close to that level. Now he's back into the oil price estimate lottery, this time projecting a end-of-year estimate for 2016 of a minimum of $52 per barrel, adding, it could double to as high as $60 per barrel.

I want to use these price misses in order to show why so many oil investors, analysts and commentators are missing on their oil price expectations, and how investors can avoid the same mistake.

The major reason for the huge misses - both on the high price end and the length of time to rebound, is the oil market is being analyzed based upon historical performance, when it fact after it has been disrupted as it has, those historical performances are no longer a reliable benchmark to work from.

source: ibtimes

It's a disruption, not a supply cycle

Until the market comes to grips with the fact this is a disruption of the oil market and not simply another supply cycle, there will continue to be wild misses on the price estimate side of oil, which will produce wrong investment choices.

I would think by now it would be very obvious this isn't business as usual with oil. If all that had to be done was OPEC to adjust its market supply, it would have already been done. It hasn't because it can't. It can't because of the shale oil revolution which has changed everything.

Not only has it added significant supply to the market, but it has added new ways of producing oil which allows companies to keep the oil in the ground and wait for the best time to bring it into production.

Also important to understand is the U.S. is only the first wave of the disruption. Most other countries with significant recoverable shale are in the early stages of exploration and development. Argentina is probably the next country to emerge as a major shale player, with others to follow over the next decade.

Using Argentina as an example, it points to the probability of much more shale oil being recoverable in the world than is now certain. After an increase in exploration, Argentina found a lot more shale oil it could recover, which pushed the global total to about 419 billion barrels. Further exploration around the world will without a doubt push that number up.

The reason this is a disruption is because it has introduced an entirely new source of oil to the market. That alone has changed the industry. Add to that the drilled but uncompleted wells that can be brought into production very quickly, and it has undermined the former way the oil business operated.

Again, this is why Saudi Arabia and OPEC can't cut production as they have in the past to boost oil prices; competitors would quickly ramp up production and increase market share and earnings at OPEC's expense. They're stuck for now.

What does remain the same

Even though the oil marketplace has been disrupted, it doesn't mean the fundamentals have changed; supply and demand is still what will drive the industry.

Some people have swung too far to the other extreme and started to think everything has changed - it hasn't. A market is still a market, and demand still drives supply, which in turn determines the price of oil. That will never change.

What has caught the market off guard has been demand has failed to materialize at projected levels, while supply has continued to exceed demand far longer than the market expected. The reason that has happened is because it was wrongly determined to be another supply cycle as in the past.

Consequently, investors were working off a wrong benchmark, which continues to skew the outlook for the price of oil; more people are starting to better understand the disruption, which will lead to more accurate outlook concerning the price of oil.

The point is this doesn't have to confuse to the point of being paralyzed in taking a position in oil. Supply and demand is still what will drive the price. What's different is how that has been impacted by shale production, and will continue to be in the future.

The China demand factor

The major region oil demand has underperformed, and will continue to disappoint the market, is with China. It seems recently every time an economic report comes out of China, it misses expectations, which has had a dramatic impact on the demand side of oil.

Demand for oil has already been significantly been downwardly revised, and I think that will increasingly be the case as we go further into 2016.

What this means to me is assertions about increased demand for oil in 2016 would rebalance the market, are not based on actual Chinese economic conditions. The Chinese economic is much weaker than believed, and it's becoming apparent it will continue to struggle. That means Chinese demand for oil will remain subdued and further erode in 2016.

Combine that will oversupply, and the outlook for oil for the rest of the year looks dismal. I see no catalyst that could change the outlook outside of a geopolitical crisis.

Why history can't be used as a benchmark

What has been causing analysts and investors to miss it widely with their outlook for the price of oil has been they have been using past historical market and market conditions as the benchmark to work from.

If all that was happening was a new player in the market, it would probably have been able to be resisted more effectively. But when you have competitors bringing new production methods to market at improved efficiency, it resulted in a new dynamic the oil industry hasn't face before. Past and present prognostications didn't take that into account, or in many cases, weren't aware of it before.

This is why OPEC is in trouble. How do you deal with major competitors able to wait on the market until the price of oil reaches profitable levels, after the cartel lowered production to support it? OPEC would lose market share to the benefit of shale producers. That is the primary factor that didn't exist in the past. It's also why now OPEC can only have a major impact on the low side of the price and not the upper end. If it lowers production and the price of oil climbs, shale producers bring more supply to the market and effectively put a ceiling on the price. That also is something that hasn't existed in the past.

Change in storage strategies

One thing I've been pointing out for some time is how shale oil itself is a form of storage. Companies don't have to bring oil into production from their drilled but uncompleted wells, so the shale acts as a form of storage by leaving it in the ground.

Beyond saving on the cost of storage, it has a more important impact on the market, which is it isn't being considered as a part of inventory, and when that is eventually started to be drawn down, a lot more oil would come to the market than is expected, which would also put downward pressure on the price of oil.

I haven't seen anybody else taking this into consideration at this time. When there is an eventual draw down of inventory, the market will learn something new very quickly. Keep this in mind for when that happens.

Not only is this a factor because of shale oil remaining in the ground, it is a factor because those wells can quickly be brought into production; in many case in under a month. This is a supply event more investors are aware of, let alone taking into consideration for the long term.

Conclusion

Beyond the additional supply of shale oil, the enduring disruption will be the methods used to produce the oil, which puts the industry in a position to control the mid and high ends of the price of oil.

Benchmarks of the past, for that reason, are no longer reliable, and it's the reason T. Boone Pickens and others miss so widely on their oil price estimates.

The error is in using history as a benchmark for current and future oil price movements. Outside of supply and demand in general, the rest has to be analyzed and understood from a market that has been disrupted, and not one that is going through another supply cycle.

With China leading the way to a faltering global economy, demand isn't going to be the catalyst oil investors are looking for in 2016. For that reason and the disruption of the shale industry as described above, those using the past as a benchmark for oil, will continue to miss how the price of oil will respond to the new market realities.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.