Slipping On Oil?

by: Douglas Tengdin, CFA

Are oil prices close to a bottom?

Source: US Department of Energy

A year ago oil prices had just started falling. Many thought that the pullback was temporary. Now the price of crude oil has plunged almost 60%, and producers are still pumping as much oil as possible-Saudi Arabia, Iraq, Russia, US shale drillers. It seems like they're playing a global game of chicken, daring one another to cut production first. And with a deal pending to end the international sanctions on Iran, they could begin ramping up. That would only add to the current glut.

Lower prices have encouraged global demand to grow almost 2 million barrels per day from a year ago. But that's not enough to absorb the excess supply, which is up 3.5 mmbd. So inventories have been climbing. It's estimated that the US has around 1.2 billion barrels of crude in inventory-not including the strategic oil reserve. Some think that this could push prices down another 40%.

Source: International Energy Agency

But it's important to keep some perspective. Our massive inventory only represents about 60 days of supply. Gasoline prices have been unusually high relative to crude oil prices, because several refineries have been off-line. There was recently a breakdown in a BP refinery outside Chicago. Still, they're about 75 cents lower than they were a year ago.

It doesn't take much of a shift in production and consumption to change these dynamics. There are currently fewer than half the number of oil rigs in operation in the US now than there were in August of 2014. This will cut into production. And sales of pickup trucks and SUVs have risen dramatically. This will increase demand.

Many worry that the collapse in oil prices presages a collapse in the global economy. But there's no evidence of a credit crunch due to problems in the oil patch. Yes, in the short run we will see layoffs among oil producers. But this is all part of a normal supply and demand cycle. In the long run, the cure for low oil prices is low oil prices.