Advertisement

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.

Advertisement - Article continues below

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.

Advertisement
Advertisement - Article continues below

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.

Advertisement - Article continues below

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.

Advertisement - Article continues below

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.

Advertisement
Advertisement - Article continues below

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."

Advertisement - Article continues below

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.

Advertisement - Article continues below

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.

Advertisement
Advertisement

Recommended

Visit/investments/commodities/600639/commodities-look-cheap
Commodities

Commodities look cheap

Gold may be on a bull run, but industrial commodities, including copper, zinc and aluminium, remain cheap.
17 Jan 2020
Visit/520272/iran-and-us-oil-price
Global Economy

What escalating tension between Iran and the US means for oil prices

The tension between the US and Iran is unlikely to mean all-out war in the Middle East. But markets may be getting a little too complacent about its e…
6 Jan 2020
Visit/519785/rising-output-will-keep-a-lid-on-the-oil-price
Oil

Rising output will keep a lid on the oil price

Oil exporters’ cartel Opec gave further encouragement to the bulls this month after agreeing to new production curbs.
20 Dec 2019
Visit/518797/brace-yourself-for-pricier-oil
Oil

Brace yourself for pricier oil

Global growth, and hence demand for oil, could surprise on the upside next year, leading to a bounce in the oil price.
29 Nov 2019

Most Popular

Visit/investments/property/601606/house-prices-crash-uk-property-prices-falling-where-next
Property

House price crash: UK property prices are falling – so where next?

With UK property prices falling for the first time in eight years, are we about to see a house price crash? John Stepek looks at what’s behind the sli…
2 Jul 2020
Visit/investments/stockmarkets/601611/nasdaq-all-time-high-markets-and-the-real-economy
Stockmarkets

How can markets hit new record highs when the economy is in such a mess?

Despite the world being in the midst of a global pandemic, America's Nasdaq stock index just hit an all-time high. And it's not the only index on a bu…
3 Jul 2020
Visit/economy/inflation/601584/the-end-of-the-bond-bull-market-and-the-return-of-inflation
Inflation

The end of the bond bull market and the return of inflation

Central bank stimulus, surging post-lockdown demand and the end of the 40-year bond bull market. It all points to inflation, says John Stepek. Here’s …
30 Jun 2020