The price floor is a long way down

The price of oil has kept on falling, but there's still further to go.

The oil price, as measured using the Brent benchmark, continued to slide early this week, hitting a new six-year low of $45 a barrel. It has now plunged by 18% this year and 60% in just six months. Analysts virtually all of whom failed to predict the trend have been racing to cut their price forecasts as a result.

Investment bank Goldman Sachs cut its forecast for the average price in the second quarter of 2015 from $80 a barrel to $42. The latest slump was partly due to a statement from oil cartel Opec.

It insisted that it would not cut production. It is hoping to force many US shale drillers a key source of new supply out of business in order to protect its market share. Traders have begun to place bets on oil falling as far as $20 a barrel.

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What the commentators said

To find a floor, said Bank of America Merrill Lynch, the market needs one of three things: Opec output cuts, non-Opec supply cuts, or higher global demand.

The latter can't be expected to materialise for some time price falls take around six months to filter through and influence the world's appetite for oil. Opec won't be cutting for the foreseeable future.That leaves non-Opec producers.

On this front, there has been a lot of talk of drilling becoming uneconomical at around $60 a barrel. But exploration and drilling cost aren't the key issue for output, said Edward Hadas on The drilling is the pricey bit, but however much that costs, a well owner will keep producing oil from a well until it costs less to close down than to run.

This "operating break-even price is typically very low and frantic cost cuts will reduce it further". The upshot is that only a small part of overall production will become uneconomical until the price is below $30.

So while drilling is beginning to slow the number of US rigs fell by 5% in the month to early January production won't follow before prices have fallen further. Indeed, this week the US Energy Information Administration forecast an increase in American production next year. The oil-price floor, concluded Hadas, "could be a long way down".

Andrew Van Sickle

Andrew is the editor of MoneyWeek magazine. He grew up in Vienna and studied at the University of St Andrews, where he gained a first-class MA in geography & international relations.

After graduating he began to contribute to the foreign page of The Week and soon afterwards joined MoneyWeek at its inception in October 2000. He helped Merryn Somerset Webb establish it as Britain’s best-selling financial magazine, contributing to every section of the publication and specialising in macroeconomics and stockmarkets, before going part-time.

His freelance projects have included a 2009 relaunch of The Pharma Letter, where he covered corporate news and political developments in the German pharmaceuticals market for two years, and a multiyear stint as deputy editor of the Barclays account at Redwood, a marketing agency.

Andrew has been editing MoneyWeek since 2018, and continues to specialise in investment and news in German-speaking countries owing to his fluent command of the language.