Gary Shilling: All-Out Price War Could Take Oil To $10 To $20 A Barrel

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

By FS Staff

On Friday and Saturday we spoke at length with the well-known author, financial analyst, and commentator Gary Shilling on his outlook for stocks, bonds, oil, the economy, and a whole host of other topics, including his 2010 book The Age of Deleveraging, which, six years later, ended up making a number of highly accurate forecasts of where we stand today.

Longtime listeners of the show will know that Gary's comments are always worth paying attention to, which is why we were especially interested to hear if he was still sticking to his forecast made last year for oil to eventually reach as low as $10 to $20 a barrel.

Using the example of a price war between gas stations, here's what Gary said:

"When you're in a price war-and that's what it is-you have to ask where is that chicken out price (before you see massive production cuts)? And this is the reason that over a year ago I said we could get to $10 to $20 a barrel. The chicken out price is not the cost of meeting budgets. For the Saudis that's $95 a barrel; Kuwait it's $45; Venezuela it's $160-it's all over the map but it's way above current prices-no, that's not the point. The price at which players chicken out isn't what they call the full cycle price-it isn't the cost of drilling a new oil well, putting in all the infrastructure, the pipes, the drilling costs and so on-no, no, no. When you're in a price war, it's the marginal cost; it's the cost of just getting the oil out of the ground when the well is drilled and the pipes are already laid. It's like a gas war with four gasoline stations on an intersection, one of them starts to cut prices and the other follow because they don't want to lose market share and they keep going. Well, where do they stop? They don't stop at the full cost of running that gas station. They stop at the point when the price of gasoline they are selling you and me is at the cost they pay to get it out the tank truck plus taxes-that's it! That's the marginal cost and that's where you end up. And the marginal cost-and this is the basis of my forecast over a year ago-the marginal cost in the best producing areas like the Permian Basin and in the Middle East is $10 to $20 a barrel and we've seen tremendous productivity growth-it's probably even getting lower!"

Gary notes that if his forecast turns out correct "that's going to create a lot of problems."