The oil price has bottomed out – here’s why

The price of oil has been flattened since last summer. Now it's hit rock bottom. John Stepek explains why you should get ready for a rebound in the price.


It won't take much for the market to change its mind on oil

The oil price has been crushed since last summer.

It's gone from over $100 a barrel (both Brent and WTI, the main benchmarks) to as low as below $50.

Two main factors have driven this: a healthy supply of oil, and strong demand for US dollars.

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But both those trends look at risk of reversing.

And that could mean a rebound for oil.

Trouble flares up in the Middle East (for a change)

As ever in the Middle East, the details are complicated (we'll look into it in more detail in the next issue of MoneyWeek magazine). But keeping things simple, the Saudis and other Gulf Arab states are fighting Iran-backed rebels in Yemen, in an attempt to defend the Yemeni government.

As the FT describes it, it's basically a Sunni-Shia cold war, with Shia Iran on one side, and the largely Sunni Arab nations on the other.

Now, Yemen doesn't matter much to the oil price. As various pundits on CNBC point out, Yemen isn't a big oil supplier, and the trouble isn't directly disrupting trade routes yet. "This could help move oil prices partly, but we don't see that this will disrupt actual oil supply," said one South Korean oil expert.

Trouble is, of course, that's just the specifics of this particular conflict. As another commentator pointed out: "If a proxy war becomes a real war, the entire Middle East will be engulfed even though I do not think that is likely." Clearly that would be much more disruptive to the oil supply, not to mention bad news in general.

Now, as we always point out, there has pretty much never been a time when you couldn't describe the Middle East as tense'. Events that look like headline-grabbing disasters one day quickly turn into a grim form of business as usual' the next.

But when the market is as bearish on oil as it is just now, it doesn't take much bad news to turn things around. For example, according to the FT, investors have the most short positions on record (in other words, they're betting on falls) in WTI. That leaves them vulnerable to a short squeeze' where a rebound in prices becomes self-reinforcing as burned bears are forced to close short positions.

The other reason for oil's massive decline

As a rule of thumb, a strong US dollar isn't going to be good news for most resource prices simply because they're priced in US dollars. And oil's slide coincides quite neatly with the US dollar's rapid surge in recent months.

But the dollar seems to have hit something of a wall this week. The Federal Reserve seemed rather hesitant this week on interest rates. Fed chief Janet Yellen is clearly in no hurry to raise rates unless she absolutely has to.

Meanwhile, economic data for the US was below par yesterday. Orders for durable goods big ticket' items fell unexpectedly in February, and the figures for January were revised down too. That gives Yellen more firepower to take it easy on rate rises.

In turn, that means the dollar could be in for a longer pullback. As the market gradually gets accustomed to the idea that rates may not rise until much later in the year if at all the strong dollar story gets harder to sell.

Overall, even if the oil price isn't due to rocket higher, there seems a good chance that it's seen the bottom for this particular crash. And the longer that prices remain low, the more likely it is that we'll end up seeing supply shortages again at some point in the future possibly more quickly than we expect.

We looked at prospects for oil in a recent MoneyWeek magazine cover story. If you're not already a subscriber, you can get your first four issues free here.

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.