Why Have Oil Prices Fallen To $85?

 |  Includes: USO
by: Bidness Etc

WTI crude oil prices have fallen below $85 per barrel due to the gloomy economic outlook. European economic headwinds and slow economic growth rates in the United States and China have brought oil inventory levels up to record highs. Due to the fundamental change in demand and supply, we have seen a decline in oil prices. The expected decrease in future oil prices has made producers lower their drilling activities, which will eventually hurt their profitability.

Oil prices have been on a downward spiral and, for the first time in the last three months, have touched $84.60 per barrel after the piling up of oil inventory. The United States Department of Energy revealed that crude oil inventory has increased by approximately 6 million barrels over the course of the last one week, which was not in line with analyst expectations. The United States' domestic oil production reached new heights last week due to the boom in shale oil production.

In our opinion, the third round of quantitative easing has failed to push up oil prices. QE3 has had a minimal effect on increasing demand for oil in the country, in addition to having a slight downward impact on the United States' currency value, and has given no support to commodity prices.

The West Texas Intermediate crude oil is trading at a discount of $22.60 when compared with Brent crude oil. We can see that this number is reaching the record gap ($30), which was previously reached last year. But the decline is not confined to WTI crude oil; Brent also witnessed a declined of $1.45 per barrel on Wednesday, touching a record low of $106.80 in the last two months. Due to the decline in global economic growth, Goldman Sachs has cut its Brent oil price forecast for next year from $130 to $110 per barrel.

Another important reason behind the decline in oil prices is the structural shift taking place from oil to gas, which poses a threat to oil consumption growth in the coming years. This transformation has increased natural gas consumption and exerted an upward pressure on natural gas prices.

The decreasing oil prices have created an alarming situation for global economic growth. Although the low oil prices enable manufacturing and other companies to improve their margins, they come at the cost of low oil demand. The European debt crisis and slow economic growth in the United States and China will further decrease oil consumption growth in the coming years. Moreover, OPEC and EIA have also decreased their oil consumption growth rates for the next year. We believe that oil prices will further show a downside, until the big economies come up with substantially effective stimuli to bring economic growth.

Investors can use the Oil ETF (NYSEARCA:USO) to play the bearish/bullish views on oil.

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

Business relationship disclosure: The article has been written by Qineqt's Energy Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.