4 Predictions for Oil in 2016

As of January 2016, over the past 18 months, oil prices experienced a sharp decline of more than 70%, falling from a high above $110 in the summer of 2014 to about $31 as of mid-January 2016. After such a dramatic market rout, predictions for 2016 cover a wide range. Particularly on prices, popularized views vary between $20 and $100 per barrel. With so much uncertainty, three key factors will shape oil prices in 2016. They include supply and demand market fundamentals; OPEC policy, especially with regard to lifting sanctions on Iran; and geopolitical tensions and the prospects for wider-scale war in the Middle East. The overall picture is negative for oil prices, which may struggle to break an average of $45 per barrel in 2016.

Prediction No. 1: Market Fundamentals Will Support Low Oil Prices for Several Years

There is no getting around the fact that there is excess supply of oil on the market. According to the International Energy Agency, as of late 2015, there were more than 3 billion barrels of spare oil on the world market. This is the result of OPEC nations, Saudi Arabia in particular, maintaining high production levels despite the fall in prices. OPEC has vigorously defended its market share as the shale oil revolution in the United States has added a relatively inexpensive and rapidly responsive oil supply to the world market. Additionally, as Iran returns to the world market after economic sanctions, it is expected to add 500,000 to 700,000 barrels per day to an already oversupplied market. Meanwhile, shale oil has responded to lower prices by cutting costs and becoming more efficient. The only meaningful hope for supply rationalization is the reduction in capital spending by large oil and gas companies, many of which are cutting capex by 15 to 25%, though this will not have an impact for several years.

On the demand side, the global macroeconomic environment is supportive of some growth but not enough to soak up the excess supply any time soon. Major economies across the globe all seem to be in a rut; the U.S. economy continues to grow at around 2.5% per year, China is slowing down, and Japan and Europe are also growing slowly. After the collapse of oil prices in 2008-2009, world energy demand growth of approximately 3 million barrels per day (mmbpd) was led in large part by China. However, the conditions in 2016 support only about 1 mmbpd of growth. This means the market will remain oversupplied for several years.

Prediction No. 2: OPEC Will Maintain a Market Share Strategy

As mentioned above, OPEC’s strategy is to hold on to market share and let market forces drive prices for the time being. Shale oil, unlike more traditional resources, can quickly come on and off the market in response to price. Cuts by OPEC nations may temporarily boost prices but only bring more shale oil onto the market, thereby eroding OPEC’s market share. As perhaps the lowest-cost producer in the world, Saudi Arabia has ramped up production in an effort to drive out higher-cost competitors. Other OPEC producers and Russia have followed suit by maintaining high levels of production.

Prediction No. 3: Geopolitical Tensions Will Not Boil Over

With civil war in Syria, ISIS controlling parts of Iraq and Libya, proxy wars between Iran and Saudi Arabia, and Russia invading the Ukraine, it may seem like global geopolitics should support higher oil prices. However, the areas under conflict have the potential to impact only a small amount of oil supply. For example, ISIS-controlled territory in Iraq is home to about 500,000 barrels per day of supply, and Libya is expected to produce only a total of 500,000 barrels per day in 2016. In other words, it would take a significant ramp-up of armed conflict to shut out enough production to shift the global supply-demand balance. According to geopolitical risk experts, this is possible but not likely in 2016; neither the United States, Saudi Arabia nor Iran want this to happen and are expected to step in if the Middle East situation becomes more dire. Moreover, Saudi Arabia has idle oil capacity it could ramp up in the event another OPEC nation cuts production.

Prediction No. 4: Oil Prices Will Average $45 in 2016

The overall picture is bearish for oil prices. Early in January 2016, reports have come out suggesting the price needs to fall to below $20 per barrel to rationalize the market and bring production off line. Even if this is not true, prices are likely to average a mere $45 per barrel in 2016 due to the dominating oversupply story detailed above.

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