The bullish and bearish cases for oil prices

The oil price is now firmly in a bear market. But saying where it goes next is tricky, says John Stepek. There are good arguments for a big move in either direction.

Shale oil jacks in North Dakota  © ROBYN BECK/AFP/Getty Images

The outlook is not a pretty one for oil producers

Shale oil jacks in North Dakota © ROBYN BECK/AFP/Getty Images

Quick note to MoneyWeek subscribers: if you haven't booked your ticket for the MoneyWeek Wealth Summit yet, then have a look in this week's issue of the magazine when it hits your doorstep there's a special subscriber discount offer. We'll also be announcing more guests very shortly keep an eye out for that.

Equity and bond markets have calmed down a little after the drama of earlier in the week.

There's not a hugely obvious reason for this beyond the fact that markets can only sustain so much panic before they get tired.

So let's quickly turn to another key asset that took a hammering this week.

Oil.

Oil is in a bear market

The price of oil has been hit hard in recent weeks. At the tail end of last month, Brent crude (the European benchmark) was trading at over $64 per barrel. As of this morning, it's trading at around $57 a barrel. The drop was even harder for WTI, the US benchmark. It's fallen from around $58 a barrel to below $53 this morning.

What's going on? I suppose it's pretty obvious. Recession and slowing growth mean a drop in demand for oil (or at least a drop in the rate of demand growth). If demand weakens more rapidly than supply, then prices fall.

Of course, it's never that simple with oil, because there's a lot of speculation and not entirely reliable data thrown into the mix. Not to mention things like unexpected production cuts, or flaring tension in the Middle East (which never goes away, but matters more some days than others).

But overall, the outlook is not a pretty one for oil producers, it seems. The International Energy Agency (IEA) has just come out with a report that suggests that oil demand growth in the first five months of 2019 was the worst it's seen since the same period in 2008. Now we all know what happened in 2008, so that's not a soothing statistic.

What's it down to? Trade tension and slowing growth. The IEA previously reckoned that oil demand in 2019 would grow by 1.5 million barrels of oil a day. It now reckons growth will come in at just 1.1 million barrels per day. That's nearly a third off and it's still one of the more optimistic views out there.

Meanwhile, supply has more than kept up. Oil cartel Opec has cut production by two million barrels a day over the past year, says the Financial Times. But growth elsewhere mostly from US shale oil is set to almost entirely offset that this year.

As a result, oil is now firmly in a bear market, with Brent down by more than 20% since April, notes the Financial Times.

I hate to say it, but oil could go either way

So what could happen next? The problem with oil right now is that you can make lots of fundamental arguments for big moves in either direction. It's not blatantly cheap or hated as it was back when it dived to $30-odd a barrel in 2016. Yet it's not obviously expensive either.

On the one hand, if we're heading into a recession and a slowdown which seems very possible then oil could go lower from here. China is particularly important. As Gregor Macdonald in The Gregor Letter points out, Chinese vehicle demand has dropped in the first five months of this year, and so has fuel consumption. Meanwhile "US gasoline demand is putting in a third year of no-growth."

There's also the issue of shale production. Opec can cut as much as it wants, but much of the shale production is now in the hands of the oil majors, who have a better ability to sustain losses in shale production because they can offset it elsewhere.

On the other, if we get a surprise on the trade front, or we get central banks loosening monetary policy in a highly aggressive manner (yes, they look as though they're struggling right now, but every single other time investors have thought that since 2008, they've pulled rabbits from hats) then maybe the gloom is overdone.

My colleague Dominic is bullish on oil for the long run. I'm ambivalent, I have to say. I struggle to have a high conviction view on oil here. It has a habit of making big sudden moves which is one very good reason to be circumspect about staking money on what it might do next.

But at the same time, I don't see a compelling reason to ditch your exposure to it (particularly as Dominic's favourite play is BHP Billiton, which also has exposure to lots of other commodities).

I realise that's not very satisfying, but I have to be honest about it. It's one of those ones that could go either way. In the longer run, I think that having more oil in the hands of more reliable trading partners, combined with a rise in electrification, could be an absolutely brilliant boon to the global economy.

But right now, the slide in prices is being driven more by fear of a slowdown so an ongoing collapse would probably be a warning sign. We'll have more on oil in tomorrow's Money Morning where we run through our "charts that matter".

PS If you're in Edinburgh this month (or you're thinking of going), don't miss our show at Adam Smith's former residence, Panmure House. Dominic Frisby, then Merryn Somerset Webb (from 17 August) are hosting panel discussions on the biggest issues of the day with various great minds in attendance (oh and I'll be there on 22nd and 23rd). Get your ticket here now.

Recommended

How to invest in copper, the most important metal in the world
Industrial metals

How to invest in copper, the most important metal in the world

As the world looks to electrify and try to move away from fossil fuels, copper looks set to be the biggest beneficiary. But how can you invest? Rupert…
30 Jun 2022
Why petrol prices are higher than in 2008, despite lower oil prices now
Inflation

Why petrol prices are higher than in 2008, despite lower oil prices now

The price of petrol is at an all-time high. Yet despite oil prices being higher in 2008, petrol was cheaper back then. Saloni Sardana explains why.
30 Jun 2022
Oil shortage starts to curb demand
Oil

Oil shortage starts to curb demand

The price of Brent crude oil is up by 475% since its March 2020 low. And when oil prices rise, people start to reduce consumption, leading to increas…
30 Jun 2022
Metals prices wobble on slowdown fears
Industrial metals

Metals prices wobble on slowdown fears

The S&P GSCI index of 24 major raw materials has fallen back 9% since mid-June on growing fears of a recession, and copper has hit a 16-month low aft…
30 Jun 2022

Most Popular

How to find the best dividend stocks
Income investing

How to find the best dividend stocks

Stocks that pay dividends tend to outperform the market over the long run - as well as providing an income. Here, Rupert Hargreaves explains the best …
28 Jun 2022
Gold has been incredibly boring to own – but that’s no bad thing right now
Gold

Gold has been incredibly boring to own – but that’s no bad thing right now

Stocks, bonds and cryptocurrencies have all seen big falls this year. But gold remains at its one-year average. It may be dull, but it’s doing what it…
29 Jun 2022
What the end of the 1970s bear market can teach today’s investors
Stockmarkets

What the end of the 1970s bear market can teach today’s investors

The 1970s saw the worst bear market Britain has ever seen, with stocks tumbling 70%. Things have changed a lot since then, says Max King. But there ar…
28 Jun 2022